Forum Selection Clause Enforced in Buyer Note Given in Acquisition of Company

Introduction

A buyer of a company wants the purchase agreement to specify that a post-closing dispute will be litigated in a state or country convenient to it. Often both sides can agree that the most convenient forum is where the target business is located.

On the other hand, a seller of a business taking back buyer’s promissory note as part of the purchase price, may want the right to go into a court convenient to the seller to enforce the note in the event of a default.

The deal

In this case the buyers were based out of Cyprus and purchased the target company from the seller who was based out of Missouri. The buyers operated the company out of Cyprus and the stock purchase agreement between the buyers and the seller had a Cyprus foreign selection clause.

As part of the deal the seller was given a $3.2 million note with a Missouri forum selection clause.

The lawsuit

Apparently, the buyers were not happy with the post-closing performance of the target company and stopped making note payments to the seller. The seller sued the buyers and his old company to collect the balance due on the note in a Missouri federal district court.

The buyers tried to convince the court to overlook the note’s Missouri forum selection clause and go with the stock purchase agreement’s Cyprus forum selection clause. The buyers argued that they were going to file a counterclaim against the seller for fraud in Cyprus because of the Cyprus form selection clause, and thus seller’s note collection claim should be litigated in Cyprus too since the seller’s claim against the buyers is connected to the buyers’ claim against the seller.

The court disagreed saying that there was no legal reason for not enforcing the note’s Missouri forum selection clause. That means the buyers will have to fight the note collection in Missouri and probably prosecute its fraud claim in Cyprus.

This case is referred to as Robson v. Duckpond LTD., No. 4:19-CV-1862 CAS., United States District Court, E.D. Missouri, Eastern Division (October 21, 2019)   

Comment

The court said it is an uphill battle to challenge a forum selection clause: “the practical result is that forum-selection clauses should control except in unusual cases.”

It is common for the buyer to stop making payments on a purchase money note if the purchased company’s performance does not match up to seller’s representations in the purchase agreement, negotiations or in the data room. In such a case the buyer would want to resolve any disputes between the buyer and the seller in one forum. Meaning that this deal’s note and purchase agreement should both have selected the same forum for dispute resolution.

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Posted in forum selection clause Tagged with: ,

Court Holds That Business Buyer Probably Acquired Founder’s Publicity Rights

Introduction

The exclusive right to use the founder’s name, likeness and goodwill in connection with the marketing and sale of the founder’s business may be a very valuable asset. And if it is, the buyer may want to acquire the exclusive right to use it to promote the buyer’s business; namely the right of publicity. This would also give the buyer the right to stop the founder from using his name, image and goodwill to promote a competitor.

The deal

This deal involved a business where the founder, Joe Traeger, is credited with inventing the wood pellet grill in the 1980s. Following this invention, Joe manufactured and sold wood pellet grills through a company owned and operated by Joe and his family. Joe and one of his sons, Brian, were well known in the industry.

In 2006 the Joe’s company sold its assets to the buyer for $3.4 million. The buyer also paid $9 million to Joe and his 3 sons for the buyer’s right to use the family’s IP, which included “personal goodwill and IP assets and properties used or usable in the business.”

The lawsuit

In 2018, a competitor of the buyer issued a marketing release announcing that it had hired Joe and Brian Traeger to elevate one of the competitor’s grill brands. The competitor’ marketing release features two photos of Joe and Brian and competitor executives, standing in front of the Traeger barn (the founder is credited with inventing the wood pellet barbeque grill in his family’s barn in the 1980s), with the Traeger name prominently displayed behind them, and a third photo of Joe Traeger and Dan Thiessen, the competitor’s CEO.

The buyer then sent the competitor a cease and desist letter, demanding that that the competitor “discontinue all activities which suggest or create the impression of a connection between the competitor and the buyer.”

In early 2019, the competitor announced that one of its grill brands planned to introduce a new series of grills in Fall 2019 called the Founders Series “brought to you proudly by Joe Traeger, the founder of the original pellet grill, and Dan Thiessen, an accomplished innovator in the pellet grill industry.” Following this announcement, the competitor began posting a series of advertisements on Instagram, Facebook and Twitter, including photos and statements featuring the names and likenesses of Joe and Brian promoting the competitor, Competitor’s products, and the Founders Series.

On July 16, 2019, buyer sued the competitor in an Arizona federal district court to stop it from using Joe and Brian’s names, images and goodwill to promote the competitor and its products. The buyer specifically asked the court to issue a preliminary injunction to stop the competitor from doing so pending the outcome of the lawsuit.

One of the conditions for issuing a preliminary injunction was that the buyer probably had exclusive right to use the names, images and goodwill of Joe and Brian to promote the sale of grills, referred to as publicity rights; and that the competitor probably had misappropriated the publicity rights. The court concluded that the buyer probably acquired these publicity rights and that the competitor probably misappropriated these rights. The court issued the preliminary injunction.

This case is referred to as Traeger Pellet Grills, LLC v. Dansons US, LLC, No. CV-19-04732-PHX-DLR, United States District Court, D. Arizona (October 3, 2019)   

Comment

The buyer had also sued Joe and Brian in a Florida district court at the same time to stop them from using their names, images and goodwill to promote the competitor. The buyer also asked the Florida court for a preliminary injunction. The court there denied the request, having doubts that the buyer had acquired Joe and Brian’s publicity rights. See my earlier blog. http://www.mk-law.com/wpblog/business-buyer-sues-seller-founder-for-using-his-personal-name-to-promote-competitor/

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Posted in personal goodwill, Right of publicity Tagged with: , , , ,

Fraud Carve-Out in APA’s Exclusive Remedy Provision Saves Buyer’s Employee Non-Solicitation Claim

Introduction

Most acquisition agreements provide that the agreement’s indemnification provisions are the exclusive remedy for a contractual breach. However, it is also common to exclude fraud claims from this excusive remedy provision.

The deal

This deal involved the acquisition of the assets of a Bakersfield, California trampoline park. The managing member of the seller of the park signed an agreement where he promised not to solicit the park’s employees to terminate their employment with the buyer.

The lawsuit

The buyer discovered after the closing that the managing member of the seller hired the general manager of the buyer’s park and was trying to hire other buyer employees to work for a competing trampoline park which was managed by the managing member of the seller. The buyer sued the managing member of the seller in a Sacramento federal district court.

The buyer claimed that the managing member of the seller violated his nonsolicitation covenant. The managing member of the seller asked the court to dismiss the claim because the buyer’s claim was not a claim for a remedy authorized in the APA’s exclusive remedy provision. The buyer disagreed saying that there is a fraud carve-out in the exclusive remedy provision that permits its claim.

The court agreed with the buyer and denied the managing member of seller’s motion to dismiss the buyer’s claim.

Here, the court said that the buyer alleged that the managing member of the seller breached his nonsolicitation covenant “by soliciting and inducing” employees of the seller’s park to terminate their employment, and recruiting those employees to work for another company managed by managing member of the seller in violation of his nonsolicitation covenant. In particular, the buyer alleged that the buyer’s park’s general manager abruptly resigned and assumed a similar general manager position at the trampoline park managed by the managing member of the seller. And that the managing member of the seller attempted to cover up his wrongful solicitation of employees in violation of his nonsolicitation covenant.

Accepting the buyer’s allegations as true, the court found that the allegations of a cover up provided enough indications that the managing member of seller engaged in intentional misconduct and willful breach of his nonsolicitation covenant.

This case is referred to as Rush Air Sports, LLC v. RDJ Group Holdings, LLC, No. 1:19-cv-00385-LJO-JLT, United States District Court, E.D. California (October 2, 2019)   

Comment

Exclusive remedy provisions and a fraud carve-out are boilerplate provisions that the businesspeople leave to the lawyers to hash out.

However, these provisions can be very important to the buyer and seller if shooting starts after the closing. In this case, the buyer was faced with a possibly serious drop in revenue caused by the loss of its general manager and possibly other employees to a competitor as a result of the managing member of the seller’s breach of his nonsolicitation covenant.

Apparently, the buyer’s potentially significant economic loss would have no remedy under the APA’s exclusive remedy provision. But an allegation of a coverup coupled with a fraud carve-out exception to the exclusive remedy provision saved the day.

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Posted in boilerplate provisions, fraud carveout, hiring seller's employees, nonsolicitation of employees and customers Tagged with: ,

Business Buyer Brings Employee Raiding Suit Against Key Seller Employee

Introduction

The value of a service business may be its employees. A major risk in an acquisition may be a mass exodus of key seller employees after the closing.

The deal

Here, the seller was an investment research firm. The buyer, which provides financial and economic research and analysis to institutional investors and newsletter products to mass market customers purchased the assets of the seller.

Key to the seller was the firm’s health policy research team. That team allegedly generated over 70% of the seller’s annual revenue.

A key seller employee managed that group. He worked for the buyer for approximately five weeks following the sale, during which time the parties engaged in negotiations regarding the terms of the employee’s continued employment. At the time, the employee managed a 2 member team that oversaw the firm’s health policy research.

The buyer and key employee could not come to terms on an employment agreement and the key employee left. The other two employees in the health policy team left the buyer on the same day. The key employee and one of his co-workers formed a competing firm the next day and the other former co-worker was hired by this new competing firm.

The lawsuit

The buyer sued the employee in a federal D.C. district court Buyer claiming that their  former key employee breached his fiduciary obligations to the firm by, prior to his departure, recruiting his two co-workers to join him in founding and operating the new business, thereby causing a “mass resignation” of the buyer’s health policy research team

The key employee filed a motion for summary judgment asking the court to dismiss the buyer’s claim against him, arguing that he did nothing wrong by hiring his two co-workers for his competing firm.  The court refused to dismiss the claim saying that the jury has a right to determine whether the key employee’s actions amount to unlawfully inducing his co-workers to leave the buyer for the key employee’s competing firm.

The court noted that the key employee owed the buyer an undivided and unselfish loyalty during the term of his employment. However, the court said that the limits of proper conduct in hiring away co-workers for your competing business is not well marked.

On one hand, “it is normally permissible for employees of a firm, or for some of its partners, to agree among themselves, while still employed, that they will engage in competition with the firm at the end of the period specified in their employment contracts.”  But, on the other hand, “a court may find that it is a breach of duty for a number of the key officers or employees to agree to leave their employment simultaneously and without giving the employer an opportunity to hire and train replacements.”

Under the so-called “pied piper” rule, the key managerial employee may breach his fiduciary duty owed to the buyer if, during his employment with the buyer, he solicits the departure of his health policy research teammates. “The rule is most clearly applicable if the supervisor-manager, as a corporate pied piper, leads all his buyer’s health policy research employees away, thus destroying the buyer’s entire business.”

Whether or not he merely presented his colleagues with an opportunity for employment elsewhere or crossed the line into `solicitation’ in violation of a fiduciary duty, is a fact question that is generally for the jury to decide.” Here, the court concluded that the buyer “offered enough— although just barely enough—circumstantial evidence to create a genuine issue of material fact” as to whether the key employee acted as a “pied piper” that led his health policy team to resign en masse.

The court noted circumstantial evidence in the record that supported the buyer’s pied piper claim. First, he and one of the other co-workers had numerous “closed-door” meetings in the days before they left the buyer, and the evidence shows that they had conversations away from the office about the possibility of starting their own business.

Second, the members of the team all resigned within an hour of each other. The key employee left the building but remained in the parking lot.  The other employees quit and left the building together in the same elevator. Third, all three left the parking lot together and went immediately to one of the co-worker’s apartment, where they began the process of establishing the competing firm which was established the next day and usurped the buyer’s entire health policy research practice.

This case is referred to as Hedgeye Risk Management, LLC v. Heldman, Civil Action No. 16-935 (RDM), United States District Court, District of Columbia (September 29, 2019)   https://scholar.google.com/scholar_case?case=7765851825007819022&q=%22asset+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017

Comment

A money carrot might be a more effective legal tool to manage this risk. Don’t know if it was considered or tried in this case. But it could include an attractive compensation package for the key employee that would be conditioned upon the employee’s successful performance over significant post-closing term of employment.

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Posted in employment agreement, hiring seller's employees, key employees of target, nonsolicitation of employees and customers, stay bonus Tagged with: ,

Business Buyer Sues Key Former Seller Employee for Using Seller Business Cards

Introduction

A key employee in a service business may have valuable personal relationships with the company’s clients. A buyer of the service business risks the key employee walking out the door with company clients after the closing.

The deal

Here, the seller was an investment research firm. The buyer, which provides financial and economic research and analysis to institutional investors and newsletter products to mass market customers, purchased the assets of the seller in December 2015.

A key seller employee worked for the buyer for approximately five weeks following the sale, during which time the parties engaged in negotiations regarding the terms of the employee’s continued employment. At the time, the employee managed a team that oversaw the firm’s health policy research. That team allegedly generated over 70% of the seller’s annual revenue.

The buyer and key employee could not come to terms on an employment agreement, including a noncompetition covenant. The key employee left, taking with him the other two members of the buyer’s health policy research team, and business cards of the seller clients that he had picked up over the years when working for the seller. The former key employee used the business cards as his source for clients in his competing business which he started immediately after leaving his employment with the buyer.

The lawsuit

The buyer sued the employee in a federal D.C. district court to stop him from contacting the buyer’s clients, claiming that the employee had breached his fiduciary duty to the buyer, as a former employee of the buyer, by misappropriating buyer’s business cards, which the buyer claimed were trade secrets, which the former employee used to compete against the buyer.

The former employee filed a motion for summary judgment asking the court to dismiss the buyer’s claim against him, arguing that he did nothing wrong by using the business cards to compete against the buyer.  The court refused to dismiss the claim saying that the jury has a right to determine whether the former employee’s actions amounted to misappropriating the buyer’s trade secrets.

The court noted that the former employee owed the buyer an undivided and unselfish loyalty during the term of his employment. But in the absence of an agreement to the contrary, he was free to compete with the buyer after termination of his employment.

Nevertheless, in his post-employment competition, the former employee could not commit wrongful acts, such as misusing buyer’s confidential information. In this case the buyer accused its former employee of misappropriating his collection of business cards, which he acquired during his time with the seller which the former employee used to create his competing firm’s client list.

The court concluded that there is a factual dispute as to whether these business cards were the equivalent of a confidential customer list; a question not for the court in a motion for summary judgment but for the fact finder at trial.

At trial the court said that the fact finder must answer the question whether the business cards were trade secrets. And that involves (1) the extent to which the information is known outside of the business; (2) the extent to which it is known by employees and others involved in the business; (3) the extent of measures taken by the buyer to guard the secrecy of the information; (4) the value of the information to the buyer and to its competitors; (5) the amount of effort or money expended by the buyer/seller in developing the information; and (6) the ease or difficulty with which the information could be properly acquired or duplicated by others.

The court noted that the fact finder will want to see other evidence not on record for the summary judgement motion such as whether the business cards contain information that is confidential and difficult to find, such as information about the identity of key decisionmakers at a client firm or those persons’ private email addresses.

This case is referred to as Hedgeye Risk Management, LLC v. Heldman, Civil Action No. 16-935 (RDM), United States District Court, District of Columbia (September 29, 2019)   https://scholar.google.com/scholar_case?case=7765851825007819022&q=%22asset+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017

Comment

With 20/20 hindsight, the buyer would want to consider offering a more lucrative employment relationship for this employee; perhaps offering an attractive compensation package that would be conditioned upon the employee’s successful performance over significant post-closing term of employment.

Email:              jmccauley@mk-law.com

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Posted in business cards, trade secret misappropriation by former seller employee Tagged with:

Buyer May Pay $1.2 Million Twice for Seller Assets Subject to Financing Statement

Introduction

One of the legal risks when purchasing a business is purchasing assets that are collateral for a loan.

The deal

This is a follow up to a deal where the buyer purchased the assets of a seller that made video lottery machines. See http://www.mk-law.com/wpblog/business-buyer-risks-loss-of-assets-to-secured-creditor/

The buyer apparently did not do a UCC search in Nevada, the state where the seller was incorporated, or it would have discovered that all of the seller’s personal property, which would include the machines and associated location contracts were secured as collateral under a $1.5 million loan made to the seller by a secured lender.

The lawsuit

After the closing, the buyer placed some of the video lottery machines in restaurants in Maryland, pursuant to location contracts. The buyer had paid the seller $1.2 million for the Maryland video lottery machines.

The seller defaulted its $1.5 million loan. The buyer sued the buyer in a Maryland federal district court and obtained a preliminary injunction from the court ordering that the revenue the restaurants paid the buyer from the Maryland machines be placed in trust pending the outcome of the lawsuit.

Later, the court granted the secured lender summary judgment and ordered the buyer to pay the secured lender the value of the Maryland machines in the amount of $1.2 million plus pre-judgment interest of $150K.

This case is referred to as Potts v. Maryland Games, LLC, Civil Action No. CBD-18-3250, United States District Court, D. Maryland, Southern Division (September 27, 2019)  

Comment

This is a strong reminder to buyers. Do a proper UCC search or you may pay twice for the assets of the target business. There is more than one place to search for UCC financing statements. But at a minimum you need to check the financing statements filed with the state where a seller entity is incorporated or if not an entity, with the state where the individual seller resides.

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Posted in due diligence, liens, UCC search Tagged with: , ,

Buyer’s Section 363 Purchase of Bankrupt Hospital Assets Is Free of Medi-Cal Liabilities

Introduction

A principal reason for buying the assets of a distressed business out bankruptcy is to purchase the assets free and clear of liabilities under Bankruptcy Code Section 363.

The deal

In this case the buyer agreed to purchase the assets of 4 California hospitals for $610 million. Each of the hospitals received Medi-Cal reimbursement from California for providing health care services to the poor under provider agreements.

However, the seller provider agreements had liabilities to California in excess of $50 million.

The lawsuit

The buyer asked the bankruptcy court to sell the provider agreements “free and clear of claims and interests” under Bankruptcy Code § 363, meaning that California would receive no payments in connection with the transfer. California resisted arguing that the provider agreements could not be sold free and clear of the liabilities because they are executory contracts; meaning that the buyer would have to assume the $50 liabilities in order to receive reimbursement under California’s Medi-Cal program.

The buyer argued that the provider agreements were not contracts but part of an entitlement program. The court agreed; saying that the provider agreements “lack a key feature found in all contracts—obligations imposed on both parties to the agreements.”

The court noted that the Medi-Cal provider agreements impose no obligations upon California. The only obligations spoken of in the Medi-Cal provider agreements pertain to the seller. Even these obligations do not constitute consideration for contract purposes, since they merely restate the seller’s pre-existing legal obligations.

The court found that the Medi-Cal provider agreements were akin to a license issued by a government agency, and therefore that the Medi-Cal provider agreements could be sold under § 363. The Medi-Cal provider agreements create a statutory entitlement to bill the Medi-Cal program for providing Medi-Cal services.

The court said that Bankruptcy Code § 363 provides that a sale Seller’s Medi-Cal provider agreements may be sold free and clear of any interest in the agreements, including the $50 million liabilities owed to California under the state’s Medi-Cal laws.

This case is referred to as In Re Verity Health System of California, Inc., Lead Case No. 2:18-bk-20151-ER, Jointly Administered With Case No. 2:18-bk-20162-ER, Case No. 2:18-bk-20163-ER., 2:18-bk-20164-ER, 2:18-bk-20165-ER, 2:18-bk-20167-ER, 2:18-bk-20168-ER, 2:18-bk-20169-ER, 2:18-bk-20171-ER, 2:18-bk-20172-ER, 2:18-bk-20173-ER, 2:18-bk-20175-ER, 2:18-bk-20176-ER, 2:18-bk-20178-ER, 2:18-bk-20179-ER, 2:18-bk-20180-ER, 2:18-bk-20181-ER, United States Bankruptcy Court, C.D. California, Los Angeles Division (September 26, 2019)  

Comment

This case illustrates the value of purchasing the assets of a distressed business in bankruptcy. But it also demonstrates that not all assets can be purchased free and clear of all liabilities. For example, purchasing executory contract such as valuable lease may come with liabilities that the buyer can’t avoid.

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Posted in bankruptcy sale, distressed business acquisitions, executory contracts, Medi-Cal provider agreements, Section 363 sale Tagged with:

Medical Practice Buyer Sues Selling Doctor for Post-Closing Taking of Patient List

Introduction

A patient list may be a valuable and confidential asset of a medical practice. Therefore, a buyer of a medical practice will want to keep the selling doctor from taking the patient list with him or her after the closing.

The deal

This case involved the purchase of an OB-GYN practice. One of the selling doctors had a falling out with the practice and was terminated after the closing. The doctor downloaded a list of the patients she had seen at the practice with the intent of contacting them after her non-solicitation had expired.

The lawsuit

The buyer learned of the doctor’s intent and sued the doctor for misappropriation of a trade secrets in a Maryland federal district court.

The doctor conceded that the patient list was a trade secret but claimed that she had not misappropriated the trade secret under either federal or state law because she had not used the patient list nor disclosed the patient list to anyone.  However, she did admit that she was going to use it when her nonsolicitation covenant expired.

The doctor asked the court to dismiss these claims in a motion for summary judgment. The court denied the request.

The court said that the doctor’s downloading of the patient list by saving it as an Excel spreadsheet file for her personal use was the acquisition of the buyer’s trade secret by improper means and that is a misappropriation of a trade secret.

This case is referred to as Maryland Physician’s Edge, LLC v. Behram, Civil Action No. DKC 17-2756, United States District Court, D. Maryland (September 20, 2019)  

Comment

The doctor could compete against the buyer after the expiration of her nonsolicitation covenant. However, that would not free her up from using buyer’s trade secret; the list of her patients from her old practice.

Email:             jmccauley@mk-law.com

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Telephone:      714 273-6291

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The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in trade secret misappropriation, trade secret misappropriation by former seller employee Tagged with:

Business Buyer Sues Seller Founder for Using His Personal Name to Promote Competitor

Introduction

The personal name of the founder of a company such as the name of an inventor or fashion designer can be a very valuable asset in an acquisition. A buyer may want to minimize the risk that the inventor or designer will use his or her personal name after the closing to promote a competitor.

The deal

In this case the founder of the selling company invented a wood pellet grill. The founder manufactured and sold his new wood pellet grills under a trademark that contained his last name through a company owned and operated by him and his family.

On February 21, 2006, the buyer purchased all the seller’s assets, including its intellectual property. The buyer paid $9 million for the IP.

The lawsuit

After the closing, the buyer sued the founder in a Florida federal district court, accusing him of using his personal name and image to promote a competitor’s product. The buyer asked the court to issue a preliminary injunction to stop the founder from doing that pending the outcome of the trial.

The court looked at the description of the intellectual property transferred in the asset purchase agreement and the assignment document. The transferred IP included “personal goodwill … used or usable in the business,” which specifically included the founder’s last name  “including but not limited to the following: … (the founder) … name and tree logo (which … (the seller) … is assigning including any rights to register, in connection with the Business only). Any other marks, logos, copyrights or other intellectual property used in connection with the Business, including without limitation likenesses of people and images used in advertising.”

The court concluded that the acquisition documents were not clear as to whether the buyer acquired the exclusive right to use the founder’s personal name and image in the wood pellet grill market. Therefore, the court denied the request for a preliminary injunction because the answer to that question depends upon the evidence to be presented by the litigants to the fact finder at trial.

This case is referred to as Traeger Pellet Grills LLC v. Traeger, Case No. 8:19-cv-1714-AEP, United States District Court, M.D. Florida, Tampa Division (September 11, 2019)  

Comment

The court talked about a New York federal court case where the court concluded that buyer acquired the exclusive right to use the seller’s fashion designer’s personal name in a commercial context under the acquisition documents.

There the designer (Joseph Abboud) transferred: “All rights to use … the words “Joseph Abboud,” “designed by Joseph Abboud,” “by Joseph Abboud,” “JOE” or “JA,” or anything similar thereto or derivative thereof, either alone or in conjunction with other words or symbols … for any and all products or services.”

P.S. About a week ago, the buyer did persuade an Arizona federal district court to issue a preliminary injunction against the competitor to stop the competitor from using the founder’s name and image in promoting its wood grill products pending the resolution of the trial. https://www.govinfo.gov/content/pkg/USCOURTS-azd-2_19-cv-04732/pdf/USCOURTS-azd-2_19-cv-04732-0.pdf

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Court Permits Business Seller to Sue Buyer for Seller CEO Retention Bonus Deal

Introduction

A business buyer often wants to retain the seller’s top management. One technique used is a lucrative retention bonus. One legal risk in using this technique is a seller claim that the retention bonus is in fact part of the purchase price for the business.

The deal

In this case the private equity owned buyer negotiated with the seller’s CEO to buy the assets of the seller’s business.  The buyer and seller agreed to an APA purchase price of $17 million.  However, when the seller signed, the seller’s owners did not know that the buyer and the seller CEO had agreed to a retention bonus for seller’s top management of $1.5 million; most of which would go to the CEO.

The seller’s owners learned about the retention bonus before the closing. Nevertheless, the owners of the seller closed the transaction.

The lawsuit

The seller sued the buyer in a Texas state court and the seller CEO in a Michigan state court 3 days after the closing. The claim against the buyer ultimately ended up in a Delaware Superior Court.

Specifically, the seller accused the buyer of bribing the seller’s CEO with the $1.5 million retention bonus in exchange for only paying $18.5 million for the company (the $1.5 retention bonus plus the $17 million purchase price) for a company worth $20 million.  One of the seller’s legal theories was that the buyer fraudulently concealed the retention bonus deal from the seller’s owners before the seller signed the APA.

The buyer asked the court to dismiss the claim because the buyer had no duty to disclose the existence of the bonus retention deal before the signing of the APA, because the buyer was not a fiduciary of the seller, but rather “an arms-length counter-party to a commercial transaction.” Furthermore, the buyer argued that the seller learned of the retention payments a month prior to the closing.

The court permitted the seller to proceed with its fraudulent concealment claim. For the purpose of the buyer’s motion to dismiss the seller’s fraudulent concealment claim, the court assumed that the retention agreement was unknown to the seller until approximately a month before the closing; that this concealment occurred during the negotiations for the purchase of the seller and if known in advance of the APA signing, would perhaps have provided the seller with an opportunity to investigate and react to the bonus retention agreement.

The court said that, the crux of the seller claim is that the retention agreement was concealed from the seller until it was too late to react. It is the concealment of the event that is the genesis of this claim. If the buyer knowingly and willfully conspired with the seller CEO to prevent the seller from gaining knowledge of the retention agreement and it was done with the specific purpose of obtaining the assets of Seller at a reduced price, the elements of fraudulent concealment are present except for causation and damages.

Furthermore, the court said that the seller’s discovery of the concealed event in advance of the execution of the APA merely relates to whether the seller was harmed by the nondisclosure or could have taken reasonable action to prevent damages from occurring. As such, the seller’s knowledge of the retention agreement before closure of the APA does not prevent this claim from proceeding forward.

However, the court said that whether the concealment was deliberate, whether the buyer intentionally kept the agreement secret to obtain an advantageous purchase price, or whether there is a connection between the concealment and damages allegedly suffered by the seller are all matters which the seller will be required to establish at trial.

This case is referred to as Pregis Performance Products LLC v. Rex Performance Products LLC, C.A. No. N18C-03-157 WCC CCLD, Superior Court of Delaware (Decided: September 4, 2019)  

Comment

The retention bonus arrangement was payable in installments beginning 4 months after the closing and installments would stop if the seller CEO was not still with the business a year after the closing. A post-closing CEO service obligation would be part of a legitimate retention bonus arrangement.

It is common for private equity to retain top target management with retention bonus arrangements. Disclosing the retention arrangement to the seller’s owners before signing the APA would have given the seller group time to decide whether the seller group wanted to go through with the deal and probably have eliminated the time, expense and stress involved with litigation in Michigan, Texas and Delaware courts.

Email:             jmccauley@mk-law.com

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

Telephone:      714 273-6291

 Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in fraudulent concealment, private equity, retention bonus Tagged with:

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