The waste control business seller had represented and warranted that it lawfully operated its business. The court held that the seller’s unlawful billing practices damaged the buyer because the revenue derived from those could not be replicated post-closing.
M&A Stories
April 5, 2022
Introduction:
When buyers acquire a business, they may sometimes uncover post-closing operations that generate revenue through illegal practices. In this particular case, the buyer discovered unlawful billing practices by the waste control business seller, which led to financial damages.
The Deal:
The seller, operating in the waste control business, was not adequately prepared for sale when the buyer expressed interest. Due to this lack of preparation, the buyer had to take full responsibility for valuing the seller’s assets. With no valuation or financial records provided by the seller, the buyer gained unrestricted access to the business’s raw financial data and records, including the owner’s personal finances. Eventually, the buyer purchased the business’s assets for $16 million in cash and equity, while the seller continued to work for the business post-closing.
The Lawsuit:
After the deal was closed, a dispute arose when the buyer withheld approximately $1.41 million of the acquisition consideration in escrow, claiming that the seller had made inaccurate representations regarding the lawful operations of the business. The buyer pointed out specific illegal practices, which the court found to be valid claims.
Firstly, the seller engaged in unlawful billing practices related to weight overages. They systematically and intentionally overcharged customers by estimating weights, contrary to industry norms. This practice grossly violated standard industry practices.
Secondly, the seller placed false liens on customer projects, unjustified by applicable law. These illegal liens resulted in revenue that could not be replicated post-closing, causing financial harm to the buyer.
Court’s Ruling:
The court ruled in favor of the buyer and awarded them $3.9 million in compensatory damages, to be paid partly from the funds held in escrow and the remainder directly by the seller. Additionally, the seller was ordered to pay pre- and post-judgment interest and the buyer’s legal fees and costs.
This case is referred to as Arwood v. Aw Site Services, LLC, C.A. No. 2019-0904-JRS, Court of Chancery of Delaware, (Submitted: December 17, 2021. Decided: March 9, 2022. Corrected: March 10, 2022. Amended: March 24, 2022.)
Comment:
Although the buyer sought to recover $11 million for fraud, the court dismissed the fraud claim. This decision was based on the fact that the buyer had full access to the seller’s books and records before closing, which should have revealed the illegal billing practices. Furthermore, there was no evidence to suggest that the seller intentionally misled the buyer about their billing practices. It is important to note that the buyer’s knowledge or awareness of the illegal billing practices does not absolve the seller of their liability for breaching the representation and warranty of lawful operations.
By John McCauley: I write about recent legal problems of buyers and sellers of small businesses.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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