This is a lesson about using net working capital purchase price adjustments. In this case the buyer purchased the assets of a business from seller out of bankruptcy.
The asset purchase agreement contained a net working capital purchase price adjustment. Under the adjustment procedure, the parties estimated the amount of the net working capital at closing. After the closing the final number was agreed to and the purchase price was adjusted.
Under this procedure the purchase price amount is increased if the final net working capital amount is more than the amount estimated at closing. The purchase price amount is reduced if the final net working capital amount is less than the amount estimated at closing.
Later, the buyer realized that the final net working capital amount was overstated by over $500,000.
The buyer went back to the bankruptcy court and asked the court to “reform” the asset purchase agreement and reduce the purchase price by over $500,000. The buyer said that the court can do this because the error was caused by a mutual mistake of buyer and seller.
The court agreed that this can be done in cases of mutual mistake, under certain circumstances. However, the court rejected buyer’s request, especially since buyer, seller and their advisors were sophisticated M&A players:
Under a theory of mutual mistake, … (the buyer) … argues that the appropriate remedy is contract reformation. Case law teaches that the appropriate standard under which to evaluate a mutual mistake depends on the nature of the evidence as well as whether the parties are sophisticated professionals:
A mutual mistake occurs when both parties to a contract share the same mistake at the time of its execution. Proving a mutual mistake requires evidence `so convincing that it [leaves] no reasonable doubt’ that the mistake occurred. A finding of mutual mistake is heavily disfavored where both parties are sophisticated professionals that were fully informed of the terms of the agreement.
This United States Bankruptcy Court case is referred to as In Re Taylor-Wharton International LLC, Case No. 15-12075 (BLS), (Jointly Administered), United States Bankruptcy Court, D. Delaware (April 12, 2018).
Comment. This is not a surprising result. The court would not bail out the buyer, at the expense of the seller. Why? Most likely because it was a mistake that could have been discovered by the buyer. There were no allegations that the seller covered up the mistake. The lesson for buyers and sellers is to be very careful when making purchase price adjustments.
By John McCauley: I help people start, grow, buy and sell their businesses.
Telephone: 714 273-6291