Seller was a membership buying service headquartered in Merrillville, Indiana (a 40-minute southeast drive from Chicago). Seller was owned by 2 private equity firms, based in Washington, D.C. and Miami, Florida.
Members of Seller paid a fee, which entitled them to buy products at a discount, directly from the manufacturer and its authorized suppliers. Product categories included home furnishings, home improvement, entertainment, outdoor, flooring, and accessories.
Vendor is a privately held company based in the Los Angeles area. It provided IT cloud services to Seller under a written contract.
On November 1, 2016, weighed down by about $185 million in debt, declining sales and lawsuits, Seller filed for chapter 11 bankruptcy.
Buyer is an Austin, Texas-based private equity firm, an affiliate of the second largest private equity and venture capital firm in China.
On February 14, 2017, the bankruptcy court entered an order approving the sale of substantially all of Seller’s assets to Buyer. The deal included a transitional services agreement which required Seller to provide Buyer with IT services under Seller’s Vendor contract during a post-closing transition period.
At that point Buyer had not decided whether it would assume Vendor’s contract. However, on April 30, 2017, Buyer gave notice to Seller that it was not going to assume Vendor’s contract.
Vendor challenged Buyer’s decision to not assume Vendor’s contract, claiming, in substance, that Buyer had to assume Vendor’s contract since it had enjoyed the benefit of Vendor’s post-closing services under the transitional services agreement.
The bankruptcy court did not agree with Vendor and Vendor appealed to a Delaware federal district court. The district court agreed with the bankruptcy court.
Buyer argued that bankruptcy law did not require Buyer to assume Vendor’s contract. Indeed, Buyer argued that Vendor’s expensive contract weighed down Seller and contributed to its bankruptcy filing.
The court held that Buyer never assumed Vendor’s contract when it received post-closing transition services from Vendor. Those services were provided by Vendor under its contract with Seller; not provided under a contract with Buyer. As the court said: “A contract cannot be assumed by conduct.”
This case is referred to as Potter v. Commissioner of Internal Revenue, Docket Nos. 4972-14, 5754-14, United States Tax Court (Filed September 17, 2018).
Comment. One of the advantages of purchasing a distressed business out of bankruptcy is that the buyer gets to decide which contracts of seller it wants to assume. Vendor tried to establish that Buyer assumed its contract by receiving transitional post-closing IT services under Vendor’s contract with Seller.
The court said that using transitional services under a contract between Seller and Vendor does not amount to Buyer’s assumption of the contract.
By John McCauley: I help people start, grow, buy and sell their businesses.
Telephone: 714 273-6291
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