A buyer of a business often wants the seller’s owner to stay on after the closing. So, buyer and seller’s owner sign a separate employment agreement at the closing. This is in addition to the deal’s purchase agreement signed by buyer and seller.
Employment agreements often have arbitration clauses. Many purchase agreements don’t. However, it is common to refer to the employment agreement in the purchase agreement, which says that the entire agreement between buyer and seller, includes the employment agreement.
In this case seller was a construction company that specialized in the design and installation of patented technology that mitigated liquefaction, which occurs when sand loses strength during earthquakes and often results in damage to structures that sit on the sand. It did not own the technology. Instead, it licensed the technology under an exclusive license covering its market in the southeastern United States.
In 2015 seller sold its business to buyer, which was the owner and licensor of the technology. As part of the deal, seller’s owner agreed to work for buyer and signed an employment agreement that contained an arbitration provision. The purchase agreement also said that the entire agreement between the parties included the employment agreement. The asset purchase agreement did not have an arbitration provision.
The deal went sour. Under the deal buyer paid nothing for seller’s goodwill. Instead buyer and seller agreed to capture goodwill in a form of earnout for seller’s owner in the employment agreement, based upon profits from the purchased business.
The earnout did not materialize and seller’s owner left buyer’s employment in August of 2017.
A year later seller’s owner sued buyer in a South Carolina court. Seller accused buyer of undermining seller owner’s rights to an earnout through buyer’s accounting practices and management decisions. Buyer asked the court to compel seller to resolve the dispute in arbitration as required by the employment agreement.
Seller said that this dispute goes to the sale of his company and that there is no arbitration clause in the asset purchase agreement. The court said it did not matter; pointing to the purchase agreement’s language that said that the deal between the parties includes the employment agreement; which had an arbitration agreement.
This case is referred to Ellington v. Hayward Baker, Inc, No. 2:18-cv-3436-DCN, United States District Court, D. South Carolina, Charleston Division, (February 28, 2019).
Are there any lessons? At least two. When selling your company, remember that a bird in the hand is worth two in the bush. In other words, it’s best to get your money in cash at closing, as opposed to relying upon the buyer to cooperate with you in making your earnout materialize.
Also, in 20/20 hindsight for seller’s owner, it would be difficult to reverse this result short of eliminating the arbitration clause from the employment agreement.
By John McCauley: I help businesses minimize risk when buying or selling a company.
Telephone: 714 273-6291
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