Court Holds That $12 Million Merger Termination Fee Payment Not Exclusive Remedy

Introduction

It is common in M&A deals for the seller to have the right to terminate an agreement by paying a significant termination fee; especially as part of a fiduciary out structure.

The deal

This case involves players in the business wholesaler market. The seller and a suitor, a competitor, began talks about merging. Ultimately, the suitor and a seller entered into a merger agreement which would result in a suitor/seller 51%/49% company.

The agreement contained several protections for the suitor, including a typical non-solicitation provision that prevented the seller from pursuing a competing transaction. The seller also agreed to terminate any discussions concerning competing transactions that had started prior to the execution of the merger agreement.

The seller, however, did have a fiduciary out provision. The seller could talk to others offering a superior proposal if it was not a material breach of the non-solicitation provision. To achieve this fiduciary out protection the seller board was first required to determine “in its good faith judgment” that there was a superior proposal on the table; after consulting with a financial advisor of internationally recognized reputation and external legal counsel.

With that finding the seller was permitted to terminate the merger agreement by paying a $12 million termination fee to the merger suitor and then the seller was permitted to pursue the superior proposal as long as it “did not arise or result from any material breach” of the non-solicitation provision. In such a case the seller would have no liability to the merger suitor except for liability for fraud or willful breach.

Prior to executing the merger agreement, the seller assured the suitor it had no interest in merging with anyone else and that no other entity was interested in a transaction with the seller. But according to suitor, the Staples group had expressed interest in acquiring the seller three days before the execution of the merger agreement. The seller’s board addressed the Staple’s buyer’s pre-signing overture in a meeting held the day before executing the merger agreement but said nothing of it to the suitor until seven weeks after signing the merger agreement.

The lawsuit

Ultimately, the seller terminated the merger agreement and paid the merger suitor the $12 million termination fee. The seller then did a deal with the Staples buyer.

The merger suitor sued the seller for damages in Court of Chancery of Delaware.  The seller moved to dismiss the lawsuit claiming that the merger suitor’s exclusive remedy for breach of the merger agreement was payment of the $12 million termination fee.

The court denied the seller’s motion to dismiss finding that the merger suitor’s allegations if true could satisfy the fraud/willful breach carveout in the exclusive remedy provision of the merger agreement.

This case is referred to as Genuine Parts Company v. Essendant Inc., C.A. No. 2018-0730-JRS, Court of Chancery of Delaware (Decided: September 9, 2019)  

Comment

In 20/20 hindsight, the seller should have kept its merger suitor in the loop about its discussions with Staples; including disclosing Staples’s interest to the merger suitor before signing the merger agreement.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million

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 exclusive remedy, fraud carveout, termination of M&A agreement, termination or breakup fee, willful breach carveout Tagged with: , , , ,

Insolvent Nonprofit Hospital’s 363(f) Sale Was Free of a $305 Million Cost Imposed by CA AG

Introduction

The sale of the assets of a nonprofit hospital in California requires the permission of the state’s attorney general.

The deal

This deal involves the Bankruptcy Code Section 363(f) sale of four California nonprofit hospitals in bankruptcy for $610 million. I talked about this deal already in connection with the bankruptcy court’s ruling that the sale would be free of $50 million of seller’s Medi-Cal liabilities. See Buyer’s Section 363 Purchase of Bankrupt Hospital Assets Is Free of Medi-Cal Liabilities; http://www.mk-law.com/wpblog/buyers-section-363-purchase-of-bankrupt-hospital-assets-is-free-of-medi-cal-liabilities/

The lawsuit

Under California law, nonprofit hospitals can’t be sold without the approval of the state of California; which can impose conditions to its consent. Here, California consented to the sale, subject to various conditions. In particular, two of the conditions imposed an additional financial burden upon the buyer of approximately $305 million. First, the conditions required that the buyer continue to operate one of the hospitals as a licensed general acute care hospital through December 2024. The buyer had agreed to maintain the hospital’s general acute care license only through December 2020. The buyer estimated that continuing to operate the hospital as a general acute care hospital for an additional four years would cost approximately $285 million.

Second, the conditions required another of the hospitals to provide annual charity care in an amount of $13 million for six fiscal years. The required charity care amount is approximately $6.4 million more than the charity care that this hospital provided in fiscal year 2019. The charity care requirement imposed an additional incremental cost of approximately $20 million.

The buyer would not close the sale absent an order finding by the bankruptcy court that the hospitals can be sold free and clear of these conditions pursuant to § 363(f) of the Bankruptcy Code.

The seller was facing very significant liquidity constraints. Recently, California began withholding certain Medi-Cal fee-for-service payments owed to the seller, for the purposing of recovering alleged Medi-Cal overpayments. As of the beginning of October 2019, California had withheld approximately $4.5 million. The seller did not have the ability to borrow under any debtor-in-possession financing facility. At this time, the seller was financed by a by agreement between the seller and the principal secured creditors. Termination of the asset purchase agreement with the buyer would constitutes an event of default under this financing agreement. The court found that it was unclear whether the seller would be able to obtain alternative financing. Further, the seller must begin the expensive process of closing the hospitals while it still possesses a significant cash buffer. In short, the failure of this sale would probably necessitate the closure of three of the four hospitals.

Under these facts, the court permitted the sale of the hospitals free and clear of California’s $305 million worth of conditions under Bankruptcy Code 363(f).

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 No. 2:18-bk-20162-ER, 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 (October 23, 2019)  

Comment

The court noted another bankruptcy acquisition where section 363(f) was very useful in the context of seller liabilities to a state. That transaction involved Massachusetts unemployment taxes.

The taxes were computed based on the seller’s “experience rating,” which was determined by the number of employees it had terminated in the past. Because the bankrupt seller had terminated most of its employees prior to selling its assets, its experiencing rating, and corresponding unemployment insurance tax liabilities, were very high.  The court approved a section 363(f) sale to its buyer free of the seller’s very high unemployment insurance tax liabilities.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million

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 bankruptcy sale, distressed business acquisitions, Section 363 sale, state approval of nonprofit hospital Tagged with: , ,

Buyer to Indemnify Business Seller for 3rd Party Asbestos Claim Punitive Damages

Introduction

Liability for asbestos claims is a common risk with manufacturing companies. Sophisticated buyers and sellers of manufacturing businesses are aware of the risk and usually manage it through an allocation between the buyer and the seller in the acquisition documents.

The deal

Here, the seller owned a division engaged in the business of manufacturing and remanufacturing brake parts for vehicle brake systems. Specifically, this division manufactured and sold automotive friction products (i.e., brake shoes), some of which were made using asbestos-containing friction lining from outside vendors.

For several years prior to the 1986 transaction with the buyer, civil lawsuits were filed against the seller alleging bodily injury as a result of alleged exposure to asbestos contained in its friction products. The seller disclosed the existence of these asbestos claims to the buyer during the due diligence that preceded the 1986 divestiture, and the parties expressly accounted for these types of actions in allocating liabilities arising out of post-closing product liability claims.

Basically, the buyer agreed to indemnify the seller for certain asbestos claims.

The lawsuit

This arrangement worked for 33 years when a California jury returned a $6 million punitive damages award in favor of a plaintiff in an asbestos case filed against the seller. The buyer claimed that punitive damages were not part of its indemnification obligation.

The seller then sued the buyer in an Ohio federal district court to resolve the dispute.

The buyer first argued that the indemnification provision in the asset purchase agreement did not refer to punitive damages, let alone expressly impose an obligation to indemnify against such damages for asbestos claims.

Construing the plain language of the asset purchase agreement, the court found that it was not ambiguous regarding liability and indemnification for punitive damages. The court said that the APA’s assumption of liabilities provision was broadly worded to include all liabilities and obligations of the seller, except for certain specified excluded liabilities; and punitive damages were not specified as excluded liabilities. The court found the asset purchase agreement’s broad assumption of all liabilities and obligations of the seller necessarily included claims for punitive damages in asbestos cases.

The court further noted that the assumption of liabilities and indemnification provisions of the asset purchase agreement were carefully negotiated between the buyer and seller and their counsel, and expressly allocated the parties’ relative liabilities as to the seller’s asbestos claims. The court found that the buyer and seller, through their counsel and with knowledge that many asbestos claims had already been filed and were currently pending, agreed that the buyer would assume all liabilities and obligations of the seller (including the seller’s asbestos claims) and indemnify the seller for from and against any and all liabilities, damages, losses, and claims.

The buyer next argued that, even if the asset purchase agreement extended indemnity to punitive damages such a provision would be void `because Ohio law prohibits the indemnification of monies paid to an award of punitive damages arising out of the insured’s own conduct. The buyer asserted that, because the punitive damages in the recent suit against the seller arose from the seller’s intentional conduct, Ohio’s public policy forbids their insurance by a third party.

The court rejected the buyer’s public policy argument stating the APA’s indemnification provision is not void as against public policy because it relates solely to the seller’s past conduct. Thus, the indemnification agreement was not a form of insurance against the seller’s future acts, but rather a negotiated solution for the financial consequences of actions that had already occurred.

In other words, the asset purchase agreement did not allow the seller to continue to engage in tortious conduct without fear of financial consequences in the form of punitive damages. Rather, the asset purchase agreement was limited solely to allocating responsibility for the seller’s past conduct. Accordingly, Ohio’s public policy concern that indemnification of punitive damages would diminish the deterrent effect of punitive damages awards, is not implicated under the circumstances presented.

This case is referred to as Parker Hannifin Corp. v. Standard Motor Products, Inc., Case No. 1:19cv00617, United States District Court, N.D. Ohio (October 23, 2019)  https://scholar.google.com/scholar_case?case=3437809212237959578&q=%22asset+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017

Comment

The buyer and seller did not foresee any risk of punitive damages for third party asbestos claims when they allocated the asbestos risk in the 1986 asset purchase agreement. And over 30 years of post-closing experience confirmed that judgment.

For new deals, however, the buyer and seller will have to decide whether third party punitive damages will be an assumed liability or excluded liability; and expressly provide for that allocation in the purchase agreement.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million

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 asbestos claims, indemnification, punitive damages Tagged with: , ,

Business Buyer’s Suit Against Seller is Hampered by Missing Due Diligence Binder

Introduction

Buying a company has many legal risks for a buyer. One of the most important tools to manage the risks of buying a business is to conduct a thorough due diligence investigation of the company.

The deal

This case involved a $2 million dollar acquisition of a California kitchen remodeling business. The seller limited the buyer’s access to his company’s documents, ostensibly to avoid employees leaving the company if they learned a sale was likely.

Thus, the buyer was limited to reviewing company documents during a meeting at the seller’s attorney’s office that were in a binder. The buyer was not permitted to keep the binder.

The lawsuit

The buyer sued the seller after the closing in a California federal district court. The buyer claimed that many of Seller’s stock purchase agreement representations were false, and that the seller’s company had significant undisclosed debts, paid many of its employees outside of formal payroll to avoid pay deductions, and lacked basic financial records.

The seller argued that the buyer should have been aware of any payroll or accounting irregularities at the seller’s company as a result of the due diligence process, and specifically as a result of Bank of the West and American Express account statements that the seller claimed were included in the due diligence binder that the buyer reviewed in the seller’s attorney’s office.

The buyer apparently did not think that the due diligence binder included this information and asked the seller to produce the binders during the discovery phase of the litigation. The seller said that he did not have them and did not know where they were.

The buyer asked the court to sanction the seller for not producing the binder by issuing an order excluding the seller from introducing any evidence of the documents that the seller claimed were made available for the buyer to review in the due diligence binder. The buyer argued that this information, especially the Bank of the West and American Express bank records procured later were not a substitute for the actual collection of documents that the buyer reviewed in the due diligence binder before closing the deal.

The court refused prohibit the seller from offering this information in evidence because the seller had no duty to preserve the binder.

This case is referred to as Cardinal v. Lupo., Case No. 18-cv-00272-JCS, United States District Court, N.D. California (September 17, 2019)   https://scholar.google.com/scholar_case?case=5341473029730680698&q=%22stock+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017

Comment

In 20/20 hindsight, the buyer would have insisted upon keeping the due diligence binders or at a minimum add a provision in the stock purchase agreement requiring the seller to preserve the due diligence binder for a reasonable period of time after the closing.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million

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 preservation of due diligence materials Tagged with: , , ,

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.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million

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 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/

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million

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 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.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million

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 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.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million

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 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.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million

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 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.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million

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

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