Explore a Delaware Court of Chancery case involving a retail shelving labels company’s M&A deal and the complexities of transaction tax deductions. Learn about the legal process, disputes, and important takeaways in sharing tax benefits during M&A transactions.
M&A Stories
December 6, 2018
In a Delaware Court of Chancery case from December 6, 2018, a Little Rock, Arkansas company specializing in retail shelving labels sought a buyer. The owner, a holding company owned by two private equity firms, entered into negotiations with a private equity firm that eventually became the winning bidder.
Key Points:
One focus of the negotiations was transaction tax deductions (such as professional fees and compensatory payments for options cancellations or bonuses), which are tax-deductible expenses incurred during a transaction. Initially, the proposal was for the buyer to pay 100% of these deductions to the seller as part of the purchase price, but this was objected to by the buyer. An agreement was reached to split the deductions, with the seller receiving 50% as and when realized, provided the seller accepted pre-closing tax indemnity.
The Legal Process:
Legal professionals handled the drafting of the stock purchase agreement. The final agreement stipulated that all transaction tax deductions were allocated to the pre-closing tax period. On November 27, 2012, the deal was executed.
Dispute:
In December 2012, the company made a substantial tax payment under the assumption that the transaction would close before the end of the year, including the value of transaction tax deductions. The transaction did close on December 27, 2012. However, during a February 21, 2013 conference call, the buyer learned that the seller had claimed the deductions pre-closing, resulting in no refund. Consequently, on February 25, 2013, the buyer alleged a breach of the agreement.
Court’s Decision:
The court found the language of the stock purchase agreement to be ambiguous and therefore examined the negotiation history. Although there was an agreement between the buyer and seller principals for a 50/50 split, this was not reflected in the agreement. The language proposed by the buyer’s lawyer to clarify the arrangement was rejected by the seller’s lawyer, and the buyer’s lawyer did not press the matter. As a result, the seller received the entire $6 million in tax deductions.
Takeaways:
Sharing tax benefits in a deal can be complex, particularly when working capital adjustments are involved. It is crucial for buyer principals, lawyers, and tax advisors to collaborate to ensure that the agreement accurately represents the tax-sharing arrangement. An alternative approach could involve agreeing on the tax benefit amount upfront and adjusting the purchase price accordingly.
Case Reference:
LSVC Holdings, LLC v. Vestcom Parent Holdings, Inc., C.A. No. 8424-VCMR, Court of Chancery of Delaware, (Decided: December 29, 2017).
By John McCauley: I help people manage their tax risk when 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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