A business buyer often wants to retain the seller’s top management. One technique used is a lucrative retention bonus. One legal risk in using this technique is a seller claim that the retention bonus is in fact part of the purchase price for the business.
In this case the private equity owned buyer negotiated with the seller’s CEO to buy the assets of the seller’s business. The buyer and seller agreed to an APA purchase price of $17 million. However, when the seller signed, the seller’s owners did not know that the buyer and the seller CEO had agreed to a retention bonus for seller’s top management of $1.5 million; most of which would go to the CEO.
The seller’s owners learned about the retention bonus before the closing. Nevertheless, the owners of the seller closed the transaction.
The seller sued the buyer in a Texas state court and the seller CEO in a Michigan state court 3 days after the closing. The claim against the buyer ultimately ended up in a Delaware Superior Court.
Specifically, the seller accused the buyer of bribing the seller’s CEO with the $1.5 million retention bonus in exchange for only paying $18.5 million for the company (the $1.5 retention bonus plus the $17 million purchase price) for a company worth $20 million. One of the seller’s legal theories was that the buyer fraudulently concealed the retention bonus deal from the seller’s owners before the seller signed the APA.
The buyer asked the court to dismiss the claim because the buyer had no duty to disclose the existence of the bonus retention deal before the signing of the APA, because the buyer was not a fiduciary of the seller, but rather “an arms-length counter-party to a commercial transaction.” Furthermore, the buyer argued that the seller learned of the retention payments a month prior to the closing.
The court permitted the seller to proceed with its fraudulent concealment claim. For the purpose of the buyer’s motion to dismiss the seller’s fraudulent concealment claim, the court assumed that the retention agreement was unknown to the seller until approximately a month before the closing; that this concealment occurred during the negotiations for the purchase of the seller and if known in advance of the APA signing, would perhaps have provided the seller with an opportunity to investigate and react to the bonus retention agreement.
The court said that, the crux of the seller claim is that the retention agreement was concealed from the seller until it was too late to react. It is the concealment of the event that is the genesis of this claim. If the buyer knowingly and willfully conspired with the seller CEO to prevent the seller from gaining knowledge of the retention agreement and it was done with the specific purpose of obtaining the assets of Seller at a reduced price, the elements of fraudulent concealment are present except for causation and damages.
Furthermore, the court said that the seller’s discovery of the concealed event in advance of the execution of the APA merely relates to whether the seller was harmed by the nondisclosure or could have taken reasonable action to prevent damages from occurring. As such, the seller’s knowledge of the retention agreement before closure of the APA does not prevent this claim from proceeding forward.
However, the court said that whether the concealment was deliberate, whether the buyer intentionally kept the agreement secret to obtain an advantageous purchase price, or whether there is a connection between the concealment and damages allegedly suffered by the seller are all matters which the seller will be required to establish at trial.
This case is referred to as Pregis Performance Products LLC v. Rex Performance Products LLC, C.A. No. N18C-03-157 WCC CCLD, Superior Court of Delaware (Decided: September 4, 2019)
The retention bonus arrangement was payable in installments beginning 4 months after the closing and installments would stop if the seller CEO was not still with the business a year after the closing. A post-closing CEO service obligation would be part of a legitimate retention bonus arrangement.
It is common for private equity to retain top target management with retention bonus arrangements. Disclosing the retention arrangement to the seller’s owners before signing the APA would have given the seller group time to decide whether the seller group wanted to go through with the deal and probably have eliminated the time, expense and stress involved with litigation in Michigan, Texas and Delaware courts.
By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million).
Telephone: 714 273-6291
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