Energy drink asset buyer bound by seller’s formula restriction agreement with 3rd party

Manufacturer is the maker and distributor of 5-Hour Energy, a well-known energy shot. In 2004, Manufacturer contracted with Seller to manufacture and package 5-Hour Energy. When Manufacturer ended the business relationship some years later—abruptly and unfairly, according to Seller—Seller had a surplus of ingredients and packaging.

Seller used the surplus to continue manufacturing 5-Hour Energy for an unspecified amount of time after the relationship ended. Seller claimed that Seller’s use of the surplus of ingredients and packaging was justified under the Uniform Commercial Code, which Seller claimed authorized Seller to recover some of Seller’s loss from Manufacturer’s termination of its business relationship with Seller.

Manufacturer and Seller then sued one another, with each claiming, among other claims, that the other had breached the contract. The protracted litigation came to an end almost two years later when Seller was on the verge of bankruptcy. Manufacturer and Seller then entered into the settlement agreement.

The settlement agreement prohibited Seller from manufacturing any new energy drinks that contained certain specified substances used in Manufacturer’s energy drink. In return for these restrictions and admissions, Manufacturer paid Seller $1.85 million.

The $1.85 million cash infusion from Manufacturer was insufficient to enable Seller to regain its financial footing. Thus, Seller talked to the owner of Buyer’s Parent Company, about the possibility of Buyer’s Parent Company acquiring Seller. Buyer’s Parent Company agreed to purchase Seller’s assets and formed a new corporation, Buyer, which entered into an asset purchase agreement with Seller.

The asset purchase agreement provided that Buyer acquired Seller’s listed assets, but Buyer was not responsible for any liabilities, liens, security interests, claims, obligations, or encumbrances of Seller except for those listed on an attached schedule—principally, debt Seller owed to a bank. The asset purchase agreement also included a reference to the settlement agreement. That asset purchase agreement provision said that the formula for energy drinks manufactured by Seller did not include certain substances described in the settlement agreement between Seller and Manufacturer.

After the closing, Buyer went into the energy shot business, under the management of Seller’s former CEO/president. Buyer marketed itself as a continuation of Seller and took on Seller’s old orders and customers. Over the next few years, Buyer produced and distributed energy shots containing substances that Seller was prohibited from using under the settlement agreement.

Manufacturer sued Buyer for breaching the settlement agreement, in a Flint, Michigan federal district court. Buyer argued that it was not bound by the settlement agreement, because Buyer did not sign the settlement agreement. The trial court concluded that Buyer was bound by the energy drink formula restrictions in the settlement agreement by virtue of the settlement agreement’s formula restrictions incorporation into the asset purchase agreement.

Buyer appealed the trial court’s finding that it was bound by the terms of the settlement agreement, once again arguing that it could not be bound by the settlement agreement because Buyer did not sign the settlement agreement. The appellate court held that Buyer was bound by the formula restrictions in the settlement agreement.

The appellate court conceded that reference to the settlement agreement in the asset purchase agreement does not by itself bind Buyer any terms of the settlement agreement. Under applicable Texas law, Buyer would be bound by formula restriction provision in the settlement agreement if the language in the asset purchase agreement indicated an intent by Buyer to be bound by that settlement agreement provision.

And that was the case here. The appellate court said that the asset purchase agreement clearly provided that the formula for energy drinks manufactured by Seller was limited by the settlement agreement between Seller and Manufacturer. The appellate court concluded that Buyer’s acknowledgment in the asset purchase agreement that Buyer’s rights to the formula were limited by the settlement agreement indicated an intent by Buyer to be bound by the settlement agreement’s formula restriction provision.

This case is referred to Innovation Ventures, LLC v. Custom Nutrition Laboratories, LLC, Nos. 17-1734, 17-1771, 17-1911, United States Court of Appeals, Sixth Circuit., (Decided and Filed: December 20, 2018).

Comment. It is important that a buyer of a company, keep a close eye on a company it acquires postclosing, especially, if the acquired company will be run postclosing, by the seller’s former management team. Should be on a post-acquisition integration checklist.

With 20/20 hindsight, for example, the top management of Buyer’s Parent Company, might have prevented the use of Manufacturer’s formula postclosing in the acquired business by Seller’s former CEO/president, had Buyer’s Parent Company tightly controlled management of postclosing operations of the acquired business, at least until Buyer’s Parent Company was comfortable with the former Seller’s CEO/president’s performance.

By John McCauley: I help people start, grow, buy and sell their businesses.

Email: jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291

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Posted in asset purchase agreement, assumed liabilities, assumption of a contract, assumption of contract by incorporation by reference

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