Explore a case study where a buyer’s right to sue sellers for $9 million in pre and post-sales tax liabilities was examined in an M&A deal. Learn about the legal arguments, court decisions, and the implications for similar situations.
July 15, 2020
Introduction:
For businesses with a nationwide presence, dealing with the complex landscape of 11,000 sales tax jurisdictions in the US can be challenging. When acquiring a large business, there’s a risk of state and local sales tax issues.
The Deal:
In this case, a stock acquisition of a national business worth $110 million was structured as a merger. The deal included standard tax representations, warranties, and indemnification provisions. An escrow of $11 million secured the purchase price.
The Lawsuit:
Following the merger, KPMG conducted a tax audit and found undisclosed sales tax liabilities, including sales made in Chicago, New Jersey, New York, and Texas. The total tax owed, along with related costs, was approximately $5 million. The selling shareholders were responsible for indemnifying the buyer against pre-merger taxes. The buyer made an indemnification claim under the escrow based on the KPMG audit findings, even though tax agencies had not yet demanded payment from the target.
The 18-month post-closing indemnification period ended, and the seller sought release of the escrow funds. The buyer disagreed, leading to a dispute taken to a New York state court.
Legal Argument:
The seller claimed that the buyer’s indemnification claim was invalid since tax authorities hadn’t formally assessed the taxes. The seller requested the court to release the escrow funds through a motion for summary judgment.
The court rejected this argument, stating that the buyer didn’t need to experience the tax liability before making a timely indemnification claim. The agreement didn’t require damages to occur before the claim’s expiration date, as long as the claim notice was timely and included a reasonable estimate of expected damages. As a result, the escrowed funds were not released to the sellers.
This case is referred to as SHAREHOLDER REPRESENTATIVE SERVS. LLC v. THE NASDAQ OMX GROUP, INC, Docket No. 651145/2014, Motion Seq. No. 006, Supreme Court, New York County, (July 5, 2016 and July 25, 2018); https://scholar.google.com/scholar_case?case=10543741897857324145&q=SHAREHOLDER+REPRESENTATIVE+SERVS.+LLC+v.+THE+NASDAQ+OMX+GROUP,+INC&hl=en&as_sdt=1000006&as_vis=1 and https://scholar.google.com/scholar_case?case=3431382646305476485&q=tax+OR+taxes+%22merger+agreement%22&hl=en&as_sdt=2006&as_ylo=2017
and 2019 NY Slip Op 07752, Supreme Court, Appellate Division, First Department, (October 29, 2019; https://law.justia.com/cases/new-york/appellate-division-first-department/2019/10241n-651145-14.html
Comment:
The buyer also seeks damages of around $4 million for post-merger sales tax. The claim is based on the allegation that the target’s management provided false information in the merger agreement’s tax representations and warranties. The management claimed they had timely filed all required tax returns and that no taxing authority had a valid reason to assess additional taxes up to the closing date.
Pursuing this claim had obstacles: the indemnification only covered pre-merger taxes, and the buyer didn’t promptly file an indemnification claim for post-merger taxes related to the breach of tax representations.
However, the buyer had an advantage in the form of a fraud exception. This allowed the buyer to sue for a false tax representation and warranty outside of the indemnification terms. This approach worked because a fraud claim wasn’t bound by the 18-month indemnification deadline.
By John McCauley: I help manage the tax risks associated with buying or selling a business.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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