Court Says That Buyer of Business Not Likely to Win Trade Secret Suit

Posted on by John McCauley

Introduction

A buyer of a business sued the seller’s owner to stop him from competing against the owner’s old business.

The deal

This case involved the sale of a seafood distribution business. The seller was a San Francisco based organic seafood supplier to restaurants across the U.S. via foodservice distributors. The co-founder and president of the seller had been working in the seafood industry for approximately thirty-nine years. He knew all his company’s suppliers and customers and he had a pre-existing relationship with many of them.

The buyer is a Boston based wholesale seafood supplier to high-end restaurants. Buyer purchased the assets of the seller in April 2018 pursuant to an asset purchase agreement. The seller’s owner worked for the buyer after the sale for a year. He then left and formed his own company and started to compete against his old business.

The lawsuit

The buyer sued the seller’s owner accusing him of stealing the sold company’s trade secrets before he left the buyer and using it to fulfill orders to buyer’s customers with his new company. The buyer claimed that this diversion of business away from the buyer caused the buyer’s “revenue to drop precipitously.”

The buyer asked the San Francisco federal district court to issue a temporary restraining order and preliminary injunction to stop the seller’s owner from using the buyer’s trade secrets and stop soliciting and contacting the buyer’s customers. The court said no saying that buyer will probably lose its lawsuit.

Why? Because the buyer’s allegations did not identify any trade secrets that the seller’s owner stole; meaning buyer information that was valuable and secret. The court noted that the buyer’s customer list could be a trade secret, but the buyer had not claimed that the customer list was not “readily ascertainable through public sources.”  And the names of buyer suppliers could not be a trade secret because those supplier names were on the buyer’s website, and “the key players in the seafood industry are well-known, and pricing in the industry is standard and not unique.”

This case is referred to CleanFISH, LLC v. Sims, Case No. 19-cv-03663-HSG, United States District Court, N.D. California, (June 28, 2019)  https://scholar.google.com/scholar_case?case=10000178774886670925&q=%22asset+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017#[1]

Comment

The buyer could have stopped the owner’s competition with a covenant not to compete. A covenant not to compete would be enforceable against the seller’s owner in California because it would have been given in connection with sale of the owner’s business. Apparently, the buyer did not get a noncompetition covenant from seller’s owner.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million).

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, trade secret misappropriation by former seller employee Tagged with: , ,

Franchise Buyer’s Fraud Claim Bars Seller’s Summary Collection of Note

Posted on by John McCauley

Introduction

It can be easy for a creditor to obtain a judgment against a debtor that has defaulted on payment of a promissory note. Essentially all the creditor must do is produce the signed note and prove nonpayment. But not in all cases.

The deal

This case involved the sale of a fitness center. During due diligence the seller furnished the buyer the fitness center’s historical revenue performance.

The asset purchase agreement provided that the buyers’ purchase was based in reliance upon the seller’s representations, and that seller warranted that no information or document provided by seller contained any untrue statements of a material fact or omitted material facts, and that the obligation concerning the accuracy of statements of material facts would continue for 1 year beyond the closing.

The buyer never made any note payments, claiming that the buyer discovered after the closing that fitness center’s historical revenue provided by the seller was overstated and that the seller did not disclose to buyer that the revenue for the fitness facility was in sharp decline.

The lawsuit

The seller sued the buyer in a New York state court and filed a motion under New York law to obtain summary judgment in the amount of the note. The seller opposed the motion claiming that the seller had committed fraud and that the buyer is entitled to have the court rescind or unwind the transaction; which would relieve the buyer for liability under the note.

The court noted that in most cases that under New York law, a creditor can obtain summary judgment on a promissory note where the debtor has admitted note default. There are exceptions and this was one of them:

“Where the Note is ‘inextricably intertwined with the obligations contained in the purchase agreement’, and a breach of that agreement is alleged, summary judgment on the Note should not be granted. Here, the Asset Purchase Agreement pertained to the purchase of the fitness facility; the Note was for the money to complete the purchase; and the Asset Purchase Agreement contained warranties by the seller as to the truth and accuracy of information provided, and that the buyer was relying upon the seller’s representation. The Court finds that the Note and asset purchase agreement are inextricably intertwined. Further, Buyer’ claim that they were fraudulently induced into entering into the Asset Purchase Agreement was sufficient to raise triable issues of fact sufficient to defeat Seller’s motion.”

This case is referred to Viveros Fitness, LLC v. JB2 Fitness, LLC, Docket No. 2018-2465, Supreme Court, Chemung County, (June 18, 2019)

Comment

The bottom line was that the buyer was given the right to challenge the note by filing paperwork alleging fraud and asking the court to rescind or unwind the deal.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million).

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, fraud in business sale, promissory note, rescission Tagged with: ,

Franchisee’s Fight with Franchisor Costs It a Sale of its Franchise

Posted on by John McCauley

Introduction

This is a story of a broken deal: a sale of a restaurant franchise that did not happen because of a dispute with the franchisor.

The deal

The case here involved a franchise for seven Tim Hortons restaurants located in Michigan. The 2016 franchise agreements called for payment of franchisor royalties, advertising and other fees. The royalty fee was calculated as a percentage of weekly gross sales and was compensation for the franchisee’s use of the franchisor’s system and trademarks. The advertising fee was calculated as a percentage of monthly gross sales and provided for advertising, sales promotion, and public relations expenditures made by the franchisor on behalf of all Tim Hortons restaurants.

As part of the franchise deal, the franchisee also leased the restaurants from the franchisor. Rent under the written leases was a percentage of monthly gross sales, as well payment of taxes, utilities, and common area assessments and charges. However, the franchisee claimed that that it reached a verbal agreement with two employees of the franchisor prior to execution of the leases, where the franchisee was only required to pay rent based on a flat percentage of gross sales; meaning no reimbursement for taxes, utilities or common area maintenance charges.

From early in the relationship, the franchisee and franchisor fought over the calculation of the amount of franchise/lease payments. Ultimately, the franchisee had had enough and decided to sell. The franchisor introduced the franchisee to a potential buyer, and they entered into an asset purchase agreement. However, the franchisor refused to approve the deal unless the franchisee paid all past due amounts, including disputed amounts.

The lawsuit

The franchisor sued the franchisee in a Florida federal district court on October 9, 2018. The next day the franchisor issued a notice of default to the franchisee which stated that the franchisee had breached the franchise agreements by failing to pay the past due amounts. On November 13, 2018, the franchisor issued a notice of termination of the franchise agreements.

The franchisee nonetheless continued to operate the restaurants and the parties continued their efforts to negotiate a resolution of their dispute. The franchisor continued to supply the franchisee with approved supplies and the franchisee continued to make certain payments for rent, royalties, and ad-fund contributions. The parties were unable to resolve their dispute, however, and in January 2019 the franchisee ceased making any payments to the franchisor.

Shortly thereafter, the franchisor cut off the franchisee’ supply of approved products. On April 25, 2019, the potential buyer terminated the asset purchase agreement that it had entered into with the franchisee. Still, the franchisee continued to operate, at first with stored supplies, and later using supplies from vendors not approved by the franchisor.

The franchisor then asked the court to stop the franchisee from using any of the franchisor’s trademarks or service marks, and from representing the restaurants as genuine and authorized Tim Hortons restaurants, pending the outcome of the litigation.

The court ordered that the franchisee to immediately stop operating its restaurants as Tim Hortons restaurants during the litigation. The court said that the franchisee had likely lost the Tim Hortons franchise when it refused to pay to the franchisor the $225K in restaurant taxes, utilities and common area maintenance charges as required in the written leases.  This obligation was clearly stated in the written leases and no prior oral understanding between the franchisee and franchisor can override that written provision.

This case is referred to Tim Hortons USA, Inc. v. Tims Milner LLC, C.A. No. 17-667 (MN)., United States District Court, D. Delaware, (June 17, 2019)

Comment

In 20/20 hindsight the franchisee should have worked out its issues with the franchisor before agreeing to sell the restaurant franchises. Had it done so it would have probably got the franchisor’s approval of the deal and pocketed a nice profit.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million).

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 approval of franchisor, asset purchase agreement, franchise sale, integration clause, no oral modifications of contract Tagged with: ,

Business Seller Can’t Break Delaware Forum Selection Clause

Posted on by John McCauley

Introduction

This case demonstrates how hard it is for a party to an M&A agreement to get out of the forum selection clause.

The deal

The buyer was a Georgia based Delaware company providing nationwide accounts receivable and revenue cycle management services for customers in the health care industry. It purchased the assets of the seller’s Louisiana business, in a strategic acquisition, pursuant to M&A documents that provided for a noncompetition and nonsolicitation provisions. The documents also contained Delaware choice of law and forum selection provisions.

The lawsuit

The buyer sued the seller after the closing to enforce the noncompetition and nonsolicitation provisions in a Delaware federal district court. The seller asked the court to ignore the Delaware forum selection clause and transfer the case to Louisiana.

The seller argued for Louisiana because nearly all the witnesses and evidence were in Louisiana; all the facts took place in Louisiana; and all the third party witnesses were in Louisiana and cannot be compelled to appear in person at trial in Delaware. (Which would probably mean testimony of out of state third parties by video).

The court noted how difficult it is to break a forum selection provision, finding no special circumstances to justify a transfer in the face of the Delaware forum selection clause: “As for Louisiana, the Court agrees with … (the seller) … that Louisiana has an interest in the dispute because it is where … (the seller resides) … and where facts giving rise to the parties’ dispute occurred. But, given that … (the buyer) … is headquartered in Georgia and operates nationally …, this case is not a “local controversy” in … Louisiana, such that Louisiana’s interest is stronger than Delaware’s interest.”

This case is referred to Advanced Reimbursement Management, LLC v. Plaisance, C.A. No. 17-667 (MN)., United States District Court, D. Delaware, (June 17, 2019)

Comment

The court also found Delaware more appropriate because the judge was required to apply Delaware law to the dispute because of the Delaware choice of law provision in the M&A documents.

Finally, the seller argued that Louisiana had a strong public policy interest in deciding noncompetition disputes involving its residents, like the Louisiana based seller. The court agreed but said this was balanced against Delaware’s strong public policy interest in deciding business disputes involving Delaware companies (like the buyer) in Delaware.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million).

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 forum selection clause Tagged with: , ,

Seller Loses Earnout Suit – No Strategic Buyer Bad Faith

Posted on by John McCauley

Introduction

The Seller got past a motion for summary judgment in its gross profits earnout lawsuit against its strategic buyer. See http://www.mk-law.com/wpblog/court-gives-pharmacy-seller-chance-to-collect-earnout/ for my earlier blog about the summary judgment motion.

But, although the seller won the battle, it ultimately lost the war at trial.

The deal

The seller provided pharmaceutical products, supplies, and consultation services to long-term care facilities in New Mexico. The buyer provides nationwide pharmacy services for skilled nursing facilities, long-term care facilities, assisted living facilities, hospitals, and other institutional care settings.

In 2013 the buyer and seller entered into an asset purchase agreement that contained an earnout. The earnout was based upon the gross profits of the business during the period between the first and 2nd anniversary of the closing.

The earnout would be $1.25 million if the gross profits from the customers of the business that stayed with the buyer through the 2nd anniversary of the closing was at least $2.2 million. The earnout would be reduced according to a formula if such gross profits were between $2.2 million and $1.87 million. No earnout would be earned if gross profits were less than $1.87 million.

The lawsuit

At the end of the 2nd anniversary of the closing the buyer told the seller that the business had missed the minimum gross profits target by about $600K; meaning that there was no earnout. The seller sued the buyer and the lawsuit ended up in a New Mexico federal district court.

The seller accused the buyer of sabotaging the business’ customer accounts, causing customers to terminate their contracts with the buyer before the two-year anniversary; and thus, depriving the seller of the earnout. The seller said that the buyer violated an implied duty of good faith and fair dealing under applicable Delaware law by managing the accounts it purchased from the seller so poorly that clients terminated their accounts and reduced the seller’s chances of earning the deferred payment.

The court was not convinced that it needed to imply a buyer covenant to use good faith in servicing the seller customers in order to give the seller an opportunity to achieve the earnout. But even if the court implied a buyer covenant to do so, the court found no bad faith on the buyer’s part to support a finding of a breach of such an implied covenant:

“The evidence does not show that … (the buyer’s) … response to customer complaints and issues, though it was often slow and unsuccessful, was a willful rendering of imperfect performance or otherwise lacked reasonable diligence. …

Though the Court is sympathetic to … (the seller’s) … frustration at the issues with … (the buyer’s) … service and its careless attitude in preparing the Deferred Payment Statement, the Court finds that… (the buyer’s) … service and accounting issues, as laid out at trial, do not rise to the level of arbitrary or unreasonable conduct. …

Thus, … (the seller) … has not met his burden to show, by a preponderance of the evidence, that … (the buyer) … acted in bad faith to deprive him of the opportunity to earn a deferred payment. …”

This case is referred to Huntingford v. Pharmacy Corporation Of America, No. 1:17-cv-1210-RB-LF, United States District Court, D. New Mexico, (June 14, 2019)

Comment

An earnout based upon revenue or gross profit is less difficult to game by the buyer since it is higher up the income statement. Nevertheless, it is still risky for the seller because it is hard to control the buyer’s post-closing behavior through language in an APA, that will force a large nationwide strategic buyer to run the seller’s business after the closing in a manner which will keep the seller’s customers and the customer’s revenues flowing through the earnout period.

Nevertheless, the New Mexico federal court felt that the seller could have improved its chances with additional APA language: “The APA is silent, however, as to the quality or level of service … (the buyer) … would be required to provide the accounts it assumed. … Still, the Court finds it likely that the Deferred Payment Clause could have been drafted to address concerns regarding the level of service … (the buyer) … would provide.”

Maybe so; but with 20/20 hindsight the seller would have done better to ditch the $1.25 million earnout in exchange for a smaller additional amount of purchase price at closing.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million).

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 earn outs, implied covenant of good faith and fair dealing Tagged with: ,

Strategic Buyer’s Refusal to Sign APA Authorized by LOI

Posted on by John McCauley

Introduction

The Mississippi high court held that an LOI gave a strategic buyer the right to not sign an APA.

The deal

The seller started operations as a Mississippi hospice in June of 2007. The founder and owner ran it until December of 2008. He then transferred the company to his sister, mom and a doctor.

At the same time the seller hired Linda to run the hospice as director of nursing and administrator. None of the owners were involved in the daily operations of the hospice.

Under Linda’s leadership, profits and revenues grew by substantial amounts. Of importance, the patient census grew from six to fifty patients by the end of 2010.

A broker asked the seller in November 2010 whether the seller was interested in selling the business to the buyer, a large Louisiana based health care company, which had a hospice segment that operated hospices nationally.

This led to the seller and buyer signing a LOI in December of 2010.  The LOI was nonbinding and conditioned on the entry into a definitive APA. The expected purchase price was $1.75 million.

The seller and buyer shot for a February 28, 2011 closing date. However, the buyer could not come to terms of employment with Linda who decided to quit the seller if the deal went through and go work for a competitor.

Furthermore, the buyer learned that many of the other seller employees would probably walk with Linda and possibly take patients. To save the deal, the buyer offered Linda a $25K bonus if she would sign a covenant not to compete. Linda would not do so, and so the buyer pulled the deal.

The seller then worked out a deal with another buyer to sell for $1.2 million. They closed but only for $500K because the seller patient census which was 50 patients back when the LOI was signed had dropped to 11 patients.

The lawsuit

The seller sued the buyer in a Mississippi court accusing it of breaching the LOI by not going through with the deal and under several other legal theories which were all rejected by the trial court. The seller appealed to the Mississippi Supreme Court.

There the seller conceded that the buyer did not breach the LOI because the buyer’s LOI obligation to buy the seller’s business was conditioned upon signing an APA; which did not happen.

Instead, the seller argued that the buyer’s conduct before the expected February 28, 2011 closing date implied buyer’s agreement to buy the seller. Primarily the seller pointed to a buyer meeting with the seller employees on February 1, where the buyer said that it was buying the hospice and taking over on March 1. The court rejected this argument finding no evidence that the buyer’s conduct implied that it had agreed to buy the seller. Instead, the evidence showed that the buyer continued in the last month to perform due diligence to see if there was a deal that made sense.

This case is referred to Gulf Coast Hospice LLC v. LHC Group Inc., No. 2017-CA-01634-SCT, Supreme Court of Mississippi, (June 6, 2019)

Comment

Mississippi does imply in every contract an implied covenant of good faith and fair dealing. The court found no bad faith on the buyer’s part in deciding not to sign an APA in the face of Linda’s refusal to sign a noncompete and the risk of the loss of other seller employees and patients.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million).

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 implied covenant of good faith and fair dealing, letter of intent, nonbinding Tagged with:

Bankruptcy Court Permits 363(f) Sale of Business Free of Pension Claim

Posted on by John McCauley

Introduction

A pension plan unsuccessfully tried to stop a company from selling a business to a buyer in a 363(f) (3) sale free and clear of the seller’s pension fund liability.

The deal

The seller was engaged in environmental and industrial services. The areas of service included industrial cleaning, environmental cleaning and remediation, and transporting hazardous and non-hazardous waste products and byproducts. The company had been in business since the 1970s, primarily in Michigan but also in Ohio, Wisconsin, and Illinois.

The seller was a party to a long standing collective agreement that required it to contribute to a multiemployer union pension fund.

In early 2018, after more than four decades of operations, the seller determined that the business required either refinancing or an infusion of substantial capital from an outside source. However, the seller found that a major obstacle to obtaining funding was the potential for a large liability to the pension fund for withdrawal liability. As a result, the efforts of the seller to obtain refinancing or an infusion of capital were unsuccessful.

The lawsuit

Therefore, the seller filed for bankruptcy and asked the bankruptcy court to approve a sale of the business assets under Bankruptcy Code section 363(f)(3) to a buyer free and clear of the seller’s $3.4 million pension fund claim. The pension fund objected to the sale of the business assets free and clear of the union claim; arguing that the seller had yet to withdraw from the plan and the business assets can’t be sold under section 363(f)(3) free and clear of a contingent liability.

The bankruptcy court rejected the union fund’s objections claiming that 363(f)3) permits the court to approve the sale of seller’s assets free of the union claims even if contingent.

This case is referred to In re: K & D Industrial Services Holding Co., Inc., et al., Chapter 11, Jointly Administered Case No. 19-43823, United States Bankruptcy Court, E.D. Michigan, Southern Division, (May 16, 2019)

Comment

The pension fund not only unsuccessfully questioned the buyer’s 363(f) right to buy the seller’s assets free and clear of a pension fund liability that was contingent. It also wanted to preserve its right to sue the buyer for the pension claim under a successor liability or alter ego theory after the closing if the circumstances warranted.

The bankruptcy court said no: “This misses the point of § 363(f). The point of the statute is not to determine who would win or lose a successor or alter ego fight some time in the future. The point of the statute is to permit a purchaser” like Buyer “to purchase assets from a bankruptcy estate free of the risk that it will be forced into such a fight in the future.”

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million).

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 363(f)(3) sale, asset purchase agreement, bankruptcy sale, distressed business acquisitions, federal multiemployer pension plan withdrawal liability, successor liability Tagged with: , , , , ,

Lawsuit Over EBITDA Earnout “Determined in Accordance With Buyer’s Historical Reporting Policies”

Posted on by John McCauley

Introduction

This is another post-closing M&A dispute over an EBITDA earnout.

The deal

The seller was a San Jose based small security guard service. It sold its assets in September 2016 to a Georgia based nationwide security company with about 160 branch offices.

The purchase price was $1.375 million payable in cash at closing and an earnout based upon the annual EBITDA of the purchased business over the next 3 years. An earnout would be payed in any of the three years that the annual EBITDA for the business reached $500K. The asset purchase agreement said that the buyer would determine EBITA “in accordance with buyer’s historical reporting policies.”

The lawsuit

The seller’s business was operated by the buyer after the closing as its San Jose branch. The seller’s owner received buyer’s monthly financials for the branch after the closing which calculated EBITDA for the branch.

The branch financials said that the San Jose branch reached the $500K annual EBITDA target in the first post-closing year. However, the buyer did not pay an earnout for that year, claiming that EBITDA needed to be calculated for the year by factoring in the seller’s owner’s historic salary as a proxy for the branch’s share of the buyer’s corporate overhead. No corporate overhead had been included as an expense in the interim monthly EBITDA branch calculations prepared by the buyer during the year.

The seller sued the buyer in a federal California district court. The court held that the APA language requiring the branch’s annual EBITDA to be determined “in accordance with buyer’s historical reporting policies” was ambiguous, meaning that the court would not preliminarily decide how corporate overhead would be dealt with as a matter of law. The result meant that the matter would, if not settled, go to trial.

This case is referred to Miranda v. US Security Associates, Inc., Case No. 18-CV-00734-LHK., United States District Court, N.D. California, San Jose Division, (May 2, 2019) https://scholar.google.com/scholar_case?case=517692208462449496&q=%22asset+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017

Comment

Use of an earnout to bridge the buyer and seller view of value is always risky. Much more so when the earnout target is based upon profit or EBITDA as opposed to revenue.

There was also more to this fight than corporate overhead allocation. Seller also accused the buyer of breaching its duty of good faith and fair dealing by grossly mismanaging the San Jose branch and causing the branch to earn substantially less income than it should have, thus depressing the seller’s earnout. The court also permitted the seller to take this claim to trial.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million).

 

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, corporate overhead, de facto merger exception, earn outs, EBITDA Tagged with: ,

Purchase Price Royalty for SaaS Business Didn’t Include Professional Fees

Posted on by John McCauley

Introduction

The seller’s purchase price royalty for sale of a software as a service business did not include post-closing hourly professional fees.

The deal

The seller is a Seattle based systems integration firm that developed a cloud-based application that lets businesses deploy a user-friendly interface on top of Microsoft’s SharePoint platform. It sold this software line to buyer, another systems integration company.

The purchase price was 30% royalties from the first 3 post-closing years of net “product license fees” up to a cap of $5 million.

The business model for the product was a subscription service.

Unfortunately, the buyer’s post-closing subscription service from the software was not enough to generate any royalty. However, the buyer did generate hourly professional fees for customers using the software that if included as “product license fees” would generate royalties for the seller.

These professional fees were for consulting services that the buyer offered to customers to customize and/or supplement the otherwise standardized software functionality. Examples of such services included migrating customers’ existing on-premises intranet (an intranet that is hosted on a customer’s servers), to a cloud-based intranet service like Microsoft SharePoint, and building customized intranet portal components that layer on top of or alongside the default software webparts.

According to the buyer, some of its larger customers requested these additional services, which cannot be accomplished simply using  the software. The buyer charged an hourly fee for the staff time spent on such services, and billed customers for these professional services fees separately from the monthly subscription fee for software. Such professional services were central to the buyer’s business even before the buyer purchased software from seller.

The lawsuit

The buyer did not include the professional fees as part of seller’s product license fees. The seller sued the buyer in a Missouri federal district court. The seller claimed that the royalties applied to the professional fees.

The royalty was computed under the asset purchase agreement based upon a percentage of the “product license fees.” However, the term “product license fees” was not defined in the APA.

The buyer argued that the term “product license fees” included only those fees paid by a customer for a monthly subscription to the product and did not include the professional fees received from the buyer’s provision of consulting services. The court agreed that the term “product license fee” is unambiguous and meant the monthly subscription fees that customers paid to access or use software; and that the professional services fees did not fall within this definition.

This case is referred to Blue Rooster LLC v. Perficient, Inc., Case No. 4:17-CV-02689-AGF, United States District Court, E.D. Missouri, Eastern Division, (May 2, 2019)

Comment

The royalty was the only profit that the seller was going to see out of the sale of this business. In 20/20 hindsight, the seller would have wanted a definition of product license fees in the asset purchase agreement which would have included the professional fees.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million).

 

Email:             jmccauley@mk-law.com

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

Telephone:      714 273-6291

Legal Disclaimer

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

Posted in purchase price, royalty Tagged with: ,

APA Integration Provision and Exclusive Remedy Clause Bars Seller Claim

Posted on by John McCauley

Introduction

A seller of a mortgage service business could not sue its asset buyer in tort for negligent misrepresentation.

The deal

The seller was a Denver based company that was formed after the 2008 financial crisis to assess and verify loan data for large banks, institutional investors, hedge funds, loan-servicing companies and other financial institutions involved in mortgage lending or investing.

The buyer is part of a 120 year old Houston based company group which includes one of the largest title companies in the U.S.

The buyer purchased most of seller’s assets in August of 2013 for $15 million in cash payable at closing and an earnout based upon the 3 year post closing performance of the business.

The lawsuit

The seller’s business struggled before the closing; partly because private label mortgage securitization had not come back after the financial crisis and due to a lawsuit brought by a large bank customer of seller for seller’s alleged breach of conflict of interest contractual representations.

This downward trend in the mortgage securitization business continued after the closing, along with the decline of financial crisis mortgage foreclosure business. Furthermore, the purchased business suffered from the loss of other major customers due to reputational damage resulting from the judgment obtained against the seller after the closing from the large bank customer lawsuit; along with other pre-closing seller behavior.

As a result, the earnout targets were not met; earnouts were not paid; and the buyer closed the business.

The seller filed for bankruptcy protection in Delaware after the large bank customer judgment and the seller sued the buyer. One of the seller’s claims was in tort for negligent misrepresentation. The seller claimed that the buyer misrepresented that it would invest in the business after the closing and was able to run the business as it had been run by seller when instead buyer stripped financial and human resources from the business and failed to provide adequate leadership; that the buyer had resources in Costa Rica that could be used to the business’s benefit when those resources would not be available until 2015; that seller’s founder would remain an important part of the business, when buyer marginalized her involvement immediately and fired her without cause in January 2014, barely five months into the first year of the earnout; and that the buyer would take steps to retain key employees, including paying retention bonuses, when it failed to retain numerous key employees, many of whom left to join competitors of Seller.

The seller claimed that if the buyer had told the truth, the seller would not have entered into the APA and would have retained its valuable assets and the business for investment in or sale to another purchaser. According to the seller, the value of such assets and the business was $42 million at closing. Accordingly, Seller claimed tort damages for its negligent misrepresentation claim of $27 million, which is the $42 million valuation minus the $15 million in consideration already paid.

The court found no misrepresentations in fact. Furthermore, more fundamentally, the court concluded that the seller could not bring a negligent misrepresentation claim in tort against the buyer as a matter of law for several reasons.

A. Under the APA’s Colorado choice of law provision, the APA integration clause preempts any duties the buyer owes to the seller other than the duties and remedies provided for in the APA: “In other words, the parties specifically contracted away tort liability, including negligent misrepresentation claims. “

B. The APA’s indemnity provision also bars the seller’s negligent misrepresentation claim. The indemnity provision was the “sole and exclusive remedy” for breach of any representation “relating to the subject matter” of the APA. Except for claims based on intentional fraud, the seller had no other remedy and waived all other causes of action for “any breach of any representation set forth herein the Agreement (or otherwise relating to the subject matter of the Agreement).

C. A negligent misrepresentation claim cannot be based on a promise to do something in the future. It must be based on a misrepresentation of a “material past or present fact.”

D. The economic loss rule further restricts the seller’s negligent misrepresentation claim. The economic loss rule states that Seller, who suffers only economic loss from the Buyer’s breach of an express or implied APA duty may not assert a tort claim for such a buyer breach absent an independent duty of care under tort law; and the seller did not asset any independent buyer duty of care owed the seller.

This case is referred to In Re Allonhill, LLC., Case No. 14-10663 (KG), Adv. Pro. No. 16-50419 (KG), United States Bankruptcy Court, D. Delaware, (Filed April 25, 2019)

Comment

Why would a seller in an M&A deal gone bad sue the buyer in tort for negligent misrepresentation? Several common reasons.

Often the right to sue for breach of the APA or other M&A agreement may be capped at a number less than the loss suffered by the seller.

Another reason is that the buyer did not breach the M&A agreement. Nevertheless, the buyer could have made material misrepresentations or omissions in the virtual data room, in other due diligence or in negotiations. In those cases, the claim is not for breach of the M&A document but for fraud or misrepresentation based upon tort, not contract law

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million).

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 earn out, economic loss doctrine, exclusive remedy, integration clause Tagged with: , ,

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