One legal risk of buying a distressed business is having to pay a seller creditor for an unassumed APA liability even when the buyer paid fair market value for the business.
The buyer in this case was a newly created subsidiary of the operator of an iron ore mine under a contract with the seller, the owner of the mine. The seller used railroad equipment to ship the iron ore which it leased from the lessor.
The mine owner’s principal owner was Steve and his son Dale was the president of the mine operator. Later Dale was hired by the seller as president in order to manage the logistics of shipping the iron ore.
Several years later iron ore prices declined. Seller could not pay its bills. It marketed the company. In the end it sold the business for $13.8 million to buyer’s acquisition subsidiary. The buyer paid a reasonable value for the business.
The seller was anxious to sell in order to pay off its creditors. However, it was significantly behind in lease payments with the lessor and was delaying payment. In fact, at the time of the deal the seller and the lessor were in litigation. The buyer group also knew that the seller was delaying payment with the lessor and planned on using the purchase price proceeds to pay off the seller’s other creditors.
The lessor was owed $2.6 million in lease breach damages and sued the buyer group in a Utah bankruptcy court. (The buyer had filed for bankruptcy.) The court ordered the buyer group to pay the lessor the $2.6 million in lease breach damages.
The court held that even though the buyer paid a reasonably equivalent value for the seller’s business, it was responsible the seller’s lease obligation under Utah’s Uniform Fraudulent Transfer Act. Specifically, a buyer of a business can be responsible for a seller liability under the UFTA if the seller sold the mining business to the buyer with actual intent to hinder, delay, or defraud the lessor.
The court pointed to the factors in this case that show this intent to hinder, delay, or defraud under the UFTA: the buyer group knew that the seller was trying to delay paying the lessor; and there was an inside relationship between the buyer group and the seller; with the buyer group being under contract as the mining operator for the seller’s mining business, and Steve was the 80% principal of the buyer group while his son Steve, was the president of the seller. This was enough even though the buyer paid a reasonably equivalent value for the mining business.
This case is referred to as In Re Black Iron, LLC, Bankruptcy No. 17-24816, Consolidated With Adv. Pro. No. 17-2088, Adv. Pro. No. 17-2094, United States Bankruptcy Court, D. Utah (August 30, 2019)
The Uniform Fraudulent Transfer Act has been renamed recently as the Uniform Voidable Transactions Act.
A buyer should be aware of the legal risks of buying the assets of a distressed business. It may be liable for unassumed seller liabilities under various federal and state statutes; including the type involved in this case.
With 20/20 hindsight, the buyer should have consulted an insolvency lawyer about how to manage the legal risks of purchasing a distressed business; including the possibility of a purchase in bankruptcy.
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).
Telephone: 714 273-6291
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