On August 31, 2016, Buyer and Sellers entered into a stock purchase agreement in which Buyer agreed to purchase all of Sellers’ shares of Target stock for $93.5 million, subject to certain post-closing adjustments. The transaction closed on October 3, 2016.
The stock purchase agreement provided that Sellers would indemnify Buyer after the closing for all of Buyer’s losses that arise from any inaccuracy in or breach of any representation or warranty made by Target in the stock purchase agreement. Under the terms of the stock purchase agreement and an accompanying escrow agreement, a $7.5 million escrow fund was established, which set aside funds to pay for indemnification obligations.
The stock purchase agreement also obligated Buyer to remit to Sellers certain tax refunds and insurance proceeds for the pre-closing period promptly after their receipt.
After the transaction closed, Buyer allegedly discovered various misrepresentations Sellers made during due diligence and in the stock purchase agreement itself. These alleged misrepresentations generally concerned three subjects: (1) Target’s compliance with immigration laws, (2) the condition of Target’s production equipment, and (3) the production capacity of its pasteurizers. Buyer filed a claim notice asking for indemnification under the stock purchase agreement for the entire amount of the escrow fund based on these alleged misrepresentations. Sellers rejected this demand.
After the closing, Buyer received tax refunds and insurance proceeds for the pre-closing period of about $1 million. After Buyer failed to remit these tax refunds and insurance proceeds to Sellers, Sellers submitted claim notices for indemnification to Buyer, requesting that these amounts be remitted to Sellers. Buyer refused to do so.
About one year after the closing, Buyer sued Sellers in a Delaware state court for fraud and for breach of Target’s representations and warranties in the stock purchase agreement. Sellers then filed counterclaims to recover from Buyer the approximately $1 million in tax refunds and insurance proceeds pertaining to the pre-closing period.
Sellers asked the court to promptly order Buyer to remit the $1M in tax refunds and insurance proceeds. Buyer resisted saying that it was excused from paying those amounts over to Sellers because Sellers had made material inaccurate representations and warranties about the Target business.
The court held that Buyer was not excused from making the tax refund and insurance proceed payments to Sellers even if Buyer believes it has valid claims against Sellers for indemnification.
The court noted that under applicable Delaware law, Buyer may be excused from performance under the stock purchase agreement if Sellers were in material breach of the stock purchase agreement. However, the court said that Buyer may not refuse to perform its contractual obligation to pay Sellers the tax refunds and insurance proceeds after Sellers’ material breach while simultaneously retaining the benefits of the stock purchase agreement by utilizing the indemnification process in the stock purchase agreement and seeking the funds in the escrow account that were set aside to pay for valid indemnification claims.
This case is referred to as Post Holdings, Inc. v. NPE Seller Rep LLC, C.A. No. 2017-0772-AGB, Court of Chancery of Delaware (Date Decided: October 29, 2018).
Comment. Buyer had minimized the risk of discovering problems about the business of Target by providing for a $7.5 million escrow.
However, apparently, the problems Buyer found amounted to more than the escrowed amount. Buyer also wanted to not pay Sellers the $1 million tax refund/insurance proceed payment it was obligated to pay Sellers promptly upon collection. The court said no.
However, with 20/20 hindsight, Buyer could have tried to put an offset or setoff provision in the stock purchase agreement that would give Buyer the right to offset any claims it is making for indemnification against any tax refund/insurance proceed payments it was obligated to pay Sellers after the closing.
By John McCauley: I help people start, grow, buy and sell their businesses.
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