Buyer of company can’t offset its obligation to pay company pre-closing tax refunds to seller against buyer’s claimed larger indemnification claim against seller

Company is a gulf coast environmental remediation company. Buyer, an affiliate of private equity firm Halifax Group LLC, became interested in Company, which was then engaged in a profitable clean-up project.

On March 31, 2014 Buyer purchased Company from Sellers under a stock purchase agreement for approximately $100 million. The stock purchase agreement provided a series of Sellers representations and warranties regarding Company’s condition and financial statements, including, among other things, that its financial condition was fairly reflected in accordance with generally accepted accounting principles; that certain liabilities and obligations were either reserved against or reflected in its financial statements; and that senior management had not received any notice that certain customers intended to terminate or reduce their relationships with Company. The stock purchase agreement further provided that Sellers would indemnify Buyer for losses arising out of certain breaches of Company’s representations and warranties.

After the closing Buyer claimed that it discovered that Sellers made a series of false and misleading statements about Company’s financial reporting, its systems, and its growth prospects. Buyer alleged that, contrary to the requirements of multiple stock purchase agreement provisions, Company’s financial records were not maintained in accordance with generally accepted accounting principles and instead materially misrepresented the company’s financial state. Additionally, Seller’s financial reporting omitted expenses and overstated revenue, resulting in a purchase price that was inflated by more than $23 million.

Buyer sued Sellers after the closing in 2015 in a New York State court, in part, for indemnification for breach of the stock purchase agreement.

A year later, while Buyer’s lawsuit was pending, Sellers brought an action against Buyer and Company in the same New York court. Sellers sued to receive from Company $2.8 million of Company’s pre-closing tax refunds. It was undisputed that Company received about $2.8 million in pre-closing tax refunds that were payable to Sellers and that Buyer was required to cause Company to release the refunds to Sellers.

Nevertheless, Buyer refused to release the refunds to Sellers because of their larger indemnification claim Buyer had against Sellers in the earlier lawsuit.

The court said that Buyer had to cause Company to release the refunds to Sellers.  There was nothing in the stock purchase agreement that permitted Buyer to setoff or offset Seller’s refunds against Buyer’s larger indemnification claim.

This case is referred to as Cricket Stockholder Rep, LLC v. Project Cricket Acquisition, Inc., Docket No. 651454/2016, Motion Seq. No. 001, Supreme Court, New York County (May 10, 2018). https://scholar.google.com/scholar_case?case=4864837335428147567&q=%22stock+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017#r[1]

Comment. The result would have been different if Buyer had a setoff or offset right provision in the stock purchase agreement. However, a seller may resist putting the provision in the purchase agreement.

Under a setoff or offset provision, a buyer has the right to offset indemnification claims it may have against the seller under the purchase agreement, against any post-closing payment obligations that buyer owes to the seller, such as deferred purchase price, noncompetition or consulting payments, or the payment of prorated tax refunds.

By John McCauley: I help people start, grow, buy and sell their businesses.

Email: jmccauley@mk-law.com

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