Seller and another shareholder, each owned 50% of Target, a large heavy construction company based in the New York City area. Buyer, a Spanish group of companies, purchased all of Target stock from the two shareholders pursuant to a stock purchase agreement.
After the closing, the federal government made a claim against Target for violations of federal law in connection with construction work done by Target prior to the closing on some of New York’s biggest infrastructure projects: 2 subway stations and a water treatment plant. These projects all involved federal financing which included requirements for a certain percentage of project participation by minority- or women-owned subcontractors or those certified by government agencies as disadvantaged.
The violations involved Target repeatedly sending reports to the Metropolitan Transit Authority and the New York City Department of Environmental Protection that inaccurately said that Target was complying with the federal government’s minority business participation rules. As a result, Target, after the closing, paid out $22.4 million to the federal government.
Also, after the closing Buyer learned that Target had received prior to closing, a subpoena from the Metropolitan Transit Authority. No one informed Buyer of the existence or receipt of that subpoena prior to the closing. This subpoena included a request for “documents related to Women Business Enterprise, Minority Business Enterprise or Disadvantaged Business Enterprise status” of certain subcontractors. Moreover, the subpoena was discussed at a Target executive committee meeting days after it was received.
The deal ended up in a lawsuit in a New Jersey federal district court and Buyer sued Seller for damages for breach of representations and warranties Seller had made in the stock purchase agreement that Target’s books and records were accurate and that there were no government investigations of Target pending nor was Target was under government investigation. The court awarded damages to Buyer.
On appeal the appellate court affirmed the award of damages to Buyer, finding that Buyer’s settlement payment and costs of dealing with the settlement were the direct result of Seller’s breach of his representation and warranty that Target’s books and records were accurate, and that Target was not under investigation by any government.
This case is referred to as Schiavone v. Dragados, SA, Nos. 16-2219, 16-2439, United States Court of Appeals, Third Circuit (Opinion filed: April 3, 2018).
Comment. Businesses that work on public projects with federal funding often rely on complying with minority business participation programs. There is a risk the such a business may be audited by a governmental entity, partly because there is a lot of gaming of the system. Those audits can result in substantial monetary payments.
Buyer certainly was helped in this case, by having representations and warranties to help it cut its losses from the pre-closing violations of federal law.
Also, due diligence can help. A buyer looking to buy a business that uses minority business participation programs should consider getting help from an expert to review any potential risks in this area.
By John McCauley: I help people start, grow, buy and sell their businesses.
Telephone: 714 273-6291
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