October 14, 2020
The buyer of a business is always concerned about the risk that the target business is not as advertised. One risk management tool is to defer payment of some of the payments to the seller until after the closing.
The buyer in this deal purchased the assets of an online business. The transaction was structured to provide for post-closing payments to the seller. The asset purchase agreement also gave the buyer the right to set-off amounts the buyer was “owed” by the seller under the asset purchase agreement.
After the closing the seller disputed buyer claims for adjustments to the purchase price and indemnification. The buyer then withheld making a $500K payment to the seller under the APA’s set-off provision.
The dispute ended up in a Louisiana state trial court. The seller challenged the buyer’s right to set-off post-closing payments owed to the seller because buyer’s claims were disputed, therefor unliquidated, and therefore not “owed” as required under the set off provision of the asset purchase agreement.
The trial court agreed with the seller, and the buyer appealed to an intermediate court of appeals. The appellate court framed the dispute: “The sole issue before this court is whether § 11.6(f) of the Asset Purchase Agreement requires that the Buyer’s indemnification claims be liquidated before they can be subject to the set-off provisions of the agreement. The Buyer argues that nothing in the contract is ambiguous, and the contract evidences no indication that liquidation was a prerequisite to the set-off rights set forth in § 11.6(f).”
The court then looked at the set off provisions: “Notwithstanding anything to the contrary in this Agreement, and without prejudice to any other right or remedy it has or may have, Buyer may set off or recoup any indemnification payments owed to it by Seller pursuant to this Article 11 against any Post-Closing Payments to the Company pursuant to Section 3.1.”
The court, in denying the buyer’s right to set-off said: “Although the trial court stated that the Buyer may be due set-off at some point in the future, it could not set off payments based on disputed amounts. We agree with the trial court. While the Buyer may be due indemnity at some point in the future based on the resolution of the claims it has asserted against the Seller, it cannot unilaterally withhold payments when the sums due, if any, are undetermined and speculative.”
This case is referred to as Admin-Media, LLC v. AC of Lafayette, LLC, No. 19-691, Court of Appeal of Louisiana, Third Circuit, (March 11, 2020)
The post-closing payments could be withheld from the seller until the dispute was resolved if they had been escrowed pursuant to a well drafted escrow arrangement.
Another concern of a set-off is if the deferred payment is evidenced by a promissory note with an acceleration provision. Under that scenario the buyer in exercising its set-off right risks accelerating the balance of the note.
The model ABA Model Asset Purchase Agreement set-off provision protects the buyer in that circumstance: “The exercise of such right of set-off by Buyer in good faith, whether or not ultimately determined to be justified, will not constitute an event of default under the Promissory Note or any instrument securing the Promissory.”
By John McCauley: I help people manage M&A risks involving privately held companies.
Telephone: 714 273-6291
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