Employees of Sold Company Win Severance Plan Benefits Fight

Introduction

One of the biggest challenges for a selling a company is the rumors getting out that it is for sale.  That rumor can make the company’s customers and suppliers very nervous. And just as importantly, it can make the company’s employees scared of losing their jobs.

Sometimes, the company will tell the employees that it is selling. But to calm fears of losing jobs, the company often promises severance benefits for employees who lose their jobs as a result of the sale. The benefits can involve a percentage of the employee’s annual base pay, plus payment of health insurance premiums for several months after a job loss.

The deal

This deal involved a publicly traded Silicon Valley based chipmaker with about 1,800 U.S. employees.

In 2015, word got out that the company was for sale.  In July, the company announced a severance plan for its U.S. employees. It consisted of 25% to 50% of their annual base salary, paid health insurance premiums for three to six months, and potentially a prorated bonus. The severance plan became effective if the company entered into a definitive acquisition agreement for the sale of the company by November 1, 2015. Then, if there was a sale, an employee terminated without cause within 18 months of the execution date of the acquisition agreement would be entitled to severance benefits.

The company entered into an acquisition agreement, a merger agreement, on September 19, 2015 with a suitor. That deal did not close because another company offered a higher price. The company and that successful buyer signed a new merger agreement on January 19, 2016 that closed on April 4, 2016.

Shortly after the closing, 8 company employees were terminated without case; all within the 18 months of the company’s entry into the September 19, 2015 merger agreement with the unsuccessful suitor; and well before the expiration of the 18 month period (probably March 19, 2017).

The new buyer refused to pay the severance benefits because its merger agreement was not signed by the November 1, 2015 severance plan deadline.

The lawsuit

The terminated employees sued the company in a California federal district court under the federal employee benefits law called ERISA. The former employees filed a motion for summary judgment, arguing that based upon the given facts and the severance plan, that they were entitled to their severance benefits as a matter of law.

The court agreed that the case was clear cut and ruled that the former employees should get their severance benefits.

This case is referred to Berman v. Microchip Technology Incorporated, Case No. 17-cv-01864-HSG, United States District Court, N.D. California, (March 22, 2019) https://scholar.google.com/scholar_case?case=3496069145728558692&q=%22merger+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017

Comment

The court said that the purpose of the severance plan was to ease the minds of employees concerned about losing their jobs because of the sale of the company. The court said that the buyer’s interpretation of the severance plan would not do that.

Under the buyer’s take of the severance plan, employees would be entitled to benefits only if the September 19, 2015 merger agreement with the unsuccessful suitor was the same one that resulted in the actual sale of the company. But that would mean that employees would not receive severance benefits if, for example, the company sold to the original suitor, but upon terms and conditions of a renegotiated merger agreement signed after the November 1, 2015 deadline. Nor would employees receive severance benefits if (as actually happened) the company received and accepted a better offer from another suitor after the November 1, 2015 deadline.

By John McCauley: I help businesses minimize risk when buying or selling a company.

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 merger agreement, severance benefits Tagged with: , ,

No Sexual Harassment Successor Liability for Law Firm Asset Buyer

Introduction

A buyer often prefers to purchase the assets of a company instead of its equity (such as stock of a corporation). One advantage of an asset purchase is that the buyer can avoid responsibility for the selling company’s liabilities; other than the liabilities the buyer expressly assumes in the asset purchase agreement.

That works well, but there are some seller liabilities that the buyer may get stuck with that the buyer did not assume. These seller liabilities are imposed on the buyer by a federal or state statute or a federal or state judicially created doctrine. In the trade these liabilities are called successor liabilities; meaning that the buyer as the successor to the seller is required to pay certain seller liabilities under certain circumstances.

The deal

In this case the seller was a law firm that in its prime had 10 offices in several states. It collected debts for creditors such as banks. However, by 2013 the firm’s business began to decline. By the beginning of 2015 the firm was down to one office.

At that point, the seller was on the verge of failure with an outstanding balance on its line of credit of $1.3 million, which was secured by all the seller’s assets, which were worth $26K.

At that time, the buyer, another debt collection law firm was interested in expanding into seller’s remaining location. The buyer agreed to purchase the seller’s assets for $15K. The purchase price was paid to the seller’s secured line of credit lender in exchange for the creditor’s release of its lien on the assets. The buyer then hired seller’s employees, and continued seller’s former operations under the buyer’s ownership.

The deal was documented by a simple asset purchase agreement. The buyer did not conduct much due diligence given the size of the deal. Also, the buyer did not assume any significant seller liabilities.

The deal closed on April 1, 2015. The seller received nothing from the buyer and had no assets; making it judgment proof.

The lawsuit

The buyer did not know when it purchased seller’s assets that a former seller employee had accused the seller of sexual harassment and retaliation (that is firing her after she complained of sexual harassment). She filed complaints for sexual harassment and retaliation against the seller with a federal and state agency in June 2014.

The former seller employee sued the buyer after the closing in a New Hampshire federal district court claiming that the buyer was responsible for seller’s sexual harassment/retaliation liability under the successor liability doctrine, because the buyer continued the seller operations, and knew about the claim, or should have known about the claim had it conducted reasonable due diligence.

The buyer pushed back, saying that the buyer did not know about the federal and state claim; there were no red flags that would make buyer suspect that seller might have a sexual harassment/retaliation claims; and furthermore, it was not reasonable for the buyer to go looking for liabilities it neither knew existed or suspected given the fact that the buyer was only paying $15K for the assets.

The court agreed with the buyer and held that buyer did not have successor liability. It found that the buyer did not know about the claim. Furthermore, the court noted that a public record search by buyer would not have found the federal and state claims, as those claims are not available to the public; unlike court actions.

This case is referred to Kratz v. Richard J. Boudreau & Associates, LLC, Case No. 15-cv-232-SM, United States District Court, D. New Hampshire, (March 22, 2019)

Comment

Even if the buyer dug deeper and discovered the claim, the court said that successor liability would not apply in this case because it would be inequitable or unfair to the buyer. Why? Because successor liability is imposed upon the buyer to encourage the buyer to preserve some of the purchase price as a source for a payment for selected seller liabilities such as sexual harassment claims.

How do asset buyers secure part of the purchase price to satisfy these kinds of claims? A buyer could hold back part of the purchase price or put part of the purchase price in escrow. And if the seller won’t do that, and the seller has a healthy balance sheet, then the buyer could obtain an asset purchase agreement indemnification from the seller to reimburse the buyer if the buyer has to pay the claim.

But those techniques would not work in this case. There was no purchase price payable to the buyer that could be held back; and the seller’s indemnification would be worthless, since the seller was bankrupt.

By John McCauley: I help businesses minimize risk when buying or selling a company.

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 actual knowledge, asset purchase agreement, constructive knowledge, due diligence, inequitable, retaliation, sexual harassment, successor liability Tagged with: , ,

Buyer Didn’t Waive Seller Breach by Amending Asset Purchase Agreement

Introduction

An acquisition of a company is sometimes done in one step: the buyer and seller sign a purchase agreement and immediately close the transaction on the same day.  This is called a simultaneous closing.

Alternatively, the buyer and seller can do what is called a deferred closing. There, the buyer and seller sign the purchase agreement on one day, and then close the transaction on a future date after certain conditions have been satisfied. This is called a deferred closing.

The deal

This deferred closing deal involved the sale of multiple nursing homes located in several southern states. Here, the buyer and seller signed an asset purchase agreement in February of 2014. The deal would close in the future after certain conditions had been satisfied.

The seller represented and warranted to the buyer in the asset purchase agreement that the seller had the authority to sell all the nursing homes. That was not the case as one nursing home was in financial difficulty and subject to a receivership action (like a bankruptcy proceeding). This meant that a court appointed receiver had the power to control and sell this nursing home, not the seller.

The seller represented and warranted to buyer that it would not enter into any new leases of the seller’s nursing homes after signing the asset purchase agreement. Nevertheless, the seller entered into 2 new nursing home leases after the asset purchase agreement was signed.

The seller represented and warranted to buyer that the only pending or threatened litigation affecting the nursing homes were listed on a schedule to the asset purchase agreement. However, there were whistleblower actions against one of the seller’s nursing homes for making false claims for federal health care reimbursements (such as Medicare) that were not disclosed in the asset purchase agreement schedule.

The seller also promised in the asset purchase agreement to provide audited financial statements for the 2010 through 2013 fiscal years. The seller never furnished the financial statements to the buyer.

The lawsuit

Two years and 152 asset purchase agreement amendments later, the buyer terminated the deal because of the seller’s breaches. The buyer sued the seller to recover the $400K deposit remaining in escrow, other damages, and its legal fees and costs; and the lawsuit ended up in a New York federal district court.

The buyer asked the court to rule that the seller breached the representations and warranties for failure to disclose the receivership and whistleblower lawsuit; that the seller breached its promise that it would not agree to any new nursing home leases after the asset purchase agreement was signed; and that the seller breached its promise to provide 4 years of financial statements to the buyer.

The seller did not dispute that it breached those provisions of the asset purchase agreement. However, the seller argued that the buyer had waived or given up its rights to sue for these breaches of the asset purchase agreement because the buyer signed asset purchase agreement amendments after knowing of the seller breaches.

The court was not impressed with the seller’s argument. It said that the asset purchase agreement stated that the buyer could only waive its rights under the asset purchase agreement by a written waiver. The seller lost this argument because the buyer did not waive any asset purchase agreement rights in writing.

This case is referred to Trodale Holdings LLC v. Bristol Healthcare Investors, No. 16 Civ. 4254 (KPF), United States District Court, S.D. New York, (March 21, 2019)

Comment

The court noted that under New York law, a buyer could waive its rights to a known seller breach if the buyer closed the deal, if the purchase agreement did not require the buyer’s waiver to be in writing. However, in this case the seller loses first because the deal never closed; and second, because the asset purchase agreement did require the buyer’s waiver to be in writing.

Here is another case were a boilerplate provision in the back of the acquisition agreement can save the day.  Requiring a written waiver of rights made this easy for the buyer to prevail on this part of the dispute.

By John McCauley: I help businesses minimize risk when buying or selling a company.

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 asset purchase agreement, boilerplate provisions, breach of representations and warranties, breach of seller's covenants, deferred closing, representations and warranties, seller's covenants, waiver provision Tagged with: , , ,

Products Liability Indemnification Claim Against Former Owner Timely

Introduction

A buyer of the stock of a company that makes products wants and often gets the stock seller to promise to pay for any products liability claims that pop up after the closing that relate to products made before the closing. This promise is usually in the indemnification provisions of the stock purchase agreement.

This provision would be triggered, for example, when a person is hurt after the closing by a product that was made before the closing. In that case, the injured person would sue the company now owned by the buyer. The buyer would then make an indemnification claim against the seller to indemnify the company for the injured person’s claim.

Under the stock purchase agreement, the company now owned by the buyer may have a deadline for making an indemnification claim against the seller. This period is referred to as a survival period.  The buyer’s right to indemnification is conditioned upon the company making an indemnification claim against the seller before the survival period expires.

The deal

This case involved the purchase of the stock of an Iowa based truck trailer design and manufacturing company. The seller promised in the stock purchase agreement to indemnify the company for any claim made by someone injured after the closing by a company product made before the closing. The survival period in the stock purchase agreement required the company to make an indemnification claim against the seller by the expiration of the applicable statute of limitations.

The deal closed December 17, 2012.

The lawsuit

On December 26, 2014, a truck driver was injured when an auger manufactured by the company before the closing broke away from its trailer and fell on top of him. In May 2016, the truck driver sued the company in an Iowa trial court, alleging defects in the auger’s design and manufacturing.

The company immediately brought the seller into the lawsuit asking the court to order the seller to indemnify the company for the truck driver’s claim. The seller refused arguing that the company’s indemnification claim was made after the expiration of the applicable Iowa statute of limitations.

Both the seller and the company agreed that the applicable Iowa statute of limitations was two years. This statute of limitations stated that the truck driver had two years to bring his products-liability action against the company from the date of his injury.

The seller read this statute to require the company to bring its indemnification claim against the seller by December 17, 2014, which is the 2nd anniversary of the closing. Therefore, the seller argued, the company’s July 2016 indemnification claim was untimely.

The company said its claim was timely. It argued that the two year period expired on December 26, 2016, the 2nd anniversary of the December 26, 2014 accident.

The trial court agreed with the seller, but an Iowa intermediate appellate court did not and reversed the decision of the trial court and held that the company’s indemnification claim was timely, and that the company was entitled to indemnification from the seller.

This case is referred to CEI Equipment Company v. Gaddis, No. 17-1544, Court of Appeals of Iowa, (filed March 20, 2019)

Comment

The seller had argued that its exposure for product liability claims was unlimited because a product made before the closing could cause an injury 5, 10 or 15 years after the closing. The court was sympathetic but said that this outcome was the result of the deal the seller made with the buyer.

Furthermore, the court noted that this type of provision in not unusual. It quoted commentary by a highly respected M&A lawyer from Selected Provisions of the ABA Model Stock Purchase Agreement, an American Bar Association publication: “However, an extended or unlimited time period for … products liability … issues… is not unusual.”

By John McCauley: I help businesses minimize risk when buying or selling a company.

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 indemnification, statute of limitations, survival of covenants Tagged with: , , ,

Seller’s Insurance Broker Sued for Failing to Add Buyer as Loss Payee

Introduction

It is not uncommon for the buyer of a business to be named as a loss payee on a seller insurance policy whether it be property, liability or business interruption coverage. As part of the process, the seller’s insurance broker usually prepares the paperwork. The broker issues a certificate of insurance to the buyer evidencing that the buyer has been added as a loss payee on the policy and notifies the carrier.

The deal

In this case the buyer, a Houston based environmental services company that recycles used motor oils and other waste products, agreed to buy Colorado based seller’s two facilities in Louisiana, and a facility in both California and Nevada for $31 million in cash and $4 million in buyer stock.

The deal was broken down into two closing: the first occurred in May 2014 and involved the Louisiana and California facilities.  The 2nd closing for the Nevada facility had to wait because it had suffered major damage from a December 2013 explosion. The Nevada deal under the asset purchase agreement would close upon the seller’s satisfaction of certain conditions pertaining to the Nevada facility, including resolution of certain title issues.

As part of the Nevada facility deal the buyer loaned the financially strapped seller about $11 million which was secured by the business interruption proceeds to be paid by the seller’s insurance carrier as a result of the December 2013 explosion.  The security was documented by the buyer being named as a lender’s loss payee under the policy.

The seller’s insurance broker issued the buyer a certificate of insurance showing that the buyer was named as a lender’s loss payee under the seller’s business interruption insurance policy. However, the seller’s insurance broker did not notify the carrier that the buyer was a lender’s loss payee.

The second closing never took place, as the Nevada facility never met the conditions required under the asset purchase agreement. The seller failed to get the Nevada facility operating at the parameters required and was unable to transfer the assets free and clear of liens or other encumbrances.

Worse, the seller, not the buyer, received the insurance proceeds, because the broker did not tell the carrier that the buyer was entitled to the proceeds as a lender’s loss payee. And Seller did not pay the $4.5 million of insurance proceeds over to the buyer.

The lawsuit

Not surprisingly, the buyer sued the insurance broker in a Chicago federal district court for failing to notify the carrier that the buyer was entitled to the insurance proceeds because it was named in the policy as a lender’s loss payee. The buyer claimed that the insurance broker, under Illinois statutory law, owed the buyer a duty of care to notify the carrier of the buyer’s addition as a loss payee on the seller’s policy.

The buyer said that had the insurance broker acted appropriately, the $4.5 million insurance proceeds would have been paid to the buyer, which in turn would have reduced the amount the seller owed the buyer under the $11 million loan.

The insurance broker claimed that it was not liable to the buyer for this result and filed a motion for summary judgment to have buyer’s claims thrown out of court. The court ruled that under the facts the buyer had made out enough of a legal case to permit the litigation to continue.

The insurance broker pointed to the certificate of insurance that it gave the buyer. The certificate stated that the certificate of insurance conferred no rights upon the buyer and that the certificate did not affirmatively or negatively amend, extend or alter the coverage afforded by the policies.

However, the court pointed to the policy itself which said the insurance broker’s issuance to the buyer of a certificate of insurance naming the buyer as a lender’s loss payee automatically added the buyer to seller’s business interruption policy, as loss payee. Furthermore, the policy stated that failure by the insurance broker to notify the carrier did not invalidate the buyer’s status as loss payee.

The insurance broker then argued that the buyer could not be a loss payee since the April 2014 loss payee designation of the buyer occurred after the December 2013 explosion. The court said that the fact that the loss occurred before the loss payee status designation did not matter under Illinois law.

This case is referred to Vertex Refining, Nv, LLC v. National Union Fire Insurance Company of Pittsburgh, Pa, No. 16 C 3498, United States District Court, N.D. Illinois, Eastern Division, (March 19, 2019)

Comment

The risk here was that the broker would not notify the carrier that the buyer was named the loss payee under the policy.  In 20/20 hindsight, the buyer should not have closed the loan until it had confirmed that the carrier was notified of the buyer’s loss payee status. If that happened, the $4.5 million insurance proceeds would have been paid to the buyer, not the seller.

By John McCauley: I help businesses minimize risk when buying or selling a company.

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 asset purchase agreement, certificate of insurance, insurance broker duty, insurance coverage, loss payee Tagged with: , ,

Buyer Faces Suit for Not Disclosing Merger Disapproval Issue

Introduction

Many M&A deals require approval of some federal or state regulator before closing. The timeline is that the buyer and seller sign a definitive acquisition agreement and then work to get the deal approved by the regulators. Either or both parties usually have a right in the agreement to terminate the transaction if governmental approval does not occur by a stated deadline.

The deal

This case involved two banks. The buyer agreed to acquire the target in a merger transaction for $39.4 million. The target had certificates of deposit under college savings programs and had investments in student loans and mortgage-backed securities. The buyer only wanted the target’s deposits. Thus, target agreed to sell its investment portfolio before the closing.

The FDIC and two state regulators had to approve the deal before it closed. The merger agreement was signed in October 2014 and the FDIC approved the merger in December 2014, followed shortly by state approvals.

However, starting earlier (March 2014) the buyer had embarked on a program of significant purchases of high-risk leveraged lending participations. The buyer’s top management became concerned about this practice about the time the merger agreement was signed and how it might impact its upcoming annual FDIC bank examination.

This risk was emphasized when the FDIC published concerns about bank purchases of this class of high-risk investments in November 2014. Also, in February 2015 an investment banking firm advised the buyer of the FDIC disapproval of leveraged lending participations as an asset class.

The deal had not closed by April 2015 when the FDIC started its annual examination of the buyer. The FDIC focused on the buyer’s leveraged lending portfolio and told the buyer that these purchases could result in the FDIC withdrawing approval of the merger.

Buyer did not mention this fact to the target before the target sold most of its student loan portfolio on April 28, 2015. In fact, on May 5, 2015 the buyer told the target to sell the target’s remaining investment assets (mortgage-backed securities) so they could close May 12th.

On May 8th the FDIC told the buyer that the FDIC was suspending merger approval. The buyer then told the target on May 11th that there was an issue about the closing; not mentioning the FDIC suspension of its merger approval.

On May 12th the target sold its mortgage-backed securities portfolio and first learned about the FDIC’s suspension of its approval of the merger from a state bank regulator.

The deal did not close, and the target ended up selling to another purchaser for $5 million less that the price the target was to receive from the buyer. Furthermore, the target claimed that the it lost $7 million of profits by selling its student loan and mortgage-backed securities portfolio in order to close the deal with the buyer at a time when the buyer had failed to disclose to the target that the deal might not go through because of the FDIC problem.

The lawsuit

The target sued the buyer in a Chicago federal district court. The target accused the buyer of fraud when it told the target on May 5, 2015 that there was an issue with the closing without disclosing the fact that the FDIC “very well could” withdraw its approval for the merger.

The target also accused the buyer of failing to promptly notify the buyer of the FDIC’s decision to suspend its approval of the merger in violation of the merger agreement. The target said that the buyer knew on May 8, 2015 of the FDIC’s suspension of its approval to the merger; and that the buyer should have said something to the target then; but did not. As a result, the target sold off its mortgaged-backed securities on May 12th; which happened to be the same day the target first learned from  a state regulator of the FDIC decision.

The buyer launched a preliminary attack on the target’s claims by filing a motion for summary judgment. The buyer asked the court to throw the target’s claims out of court, arguing that there was no buyer fraud or breach of the merger agreement, even assuming all the above facts are true. The court disagreed and permitted the target’s claims to proceed.

This case is referred to O’Donoghue v. Inland Bank and Trust, No. 15 C 11603, United States District Court, N.D. Illinois, Eastern Division, (March 19, 2019)

Comment

Honesty is the best policy. The buyer should have told the target of the FDIC problem when it first learned about it; especially knowing that the target was liquidating its investment portfolio in order to close the deal.

By John McCauley: I help businesses minimize risk when buying or selling a company.

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 FDIC approval, governmental approval of transaction, merger agreement Tagged with: , ,

Company Buyer Stops Note Payments to Seller, Claims Inaccurate Books

Introduction

A buyer of a business never knows for sure what it is getting until after the closing. How does a buyer minimize the risk of overpaying for a business?

Well, in addition to kicking the tires (due diligence), the buyer wants the seller to make representations and warranties about the business; especially about the books and records. These representations and warranties if materially true should help minimize the risk that the buyer overpays for the business.

But what if a seller representation and warranty about the business is not true? And the business is worth less than the agreed purchase price?

If that is true and the buyer has paid the purchase price in cash at the closing, then the buyer will have to make a claim against the seller for the overpayment. That may be difficult. The seller may deny that the representation and warranty was inaccurate, or the seller may not have assets available to repay the buyer.

How can the buyer minimize those risks? One solution is to escrow a significant amount of the purchase price in an escrow for a period such as 18 months. Another solution is to defer payment on a portion of the purchase price and give the buyer the right to set off against the deferred purchase price and withhold from the seller an amount representing the buyer’s damages suffered from the seller’s inaccurate representation and warranty.

The deal

The buyer here agreed to buy the seller’s business for $1,175,000. The buyer paid $175K in cash at closing and delivered a $1 million note to the seller for the balance. The note gave the buyer the right to set off against the note payments and withhold those note payments for any damages the buyer suffered from inaccuracies in the seller’s representations and warranties.

After the closing the buyer claimed that the books and records of the business were not accurate; and that the business was worth less than the agreed purchase price. The buyer stopped making note payments to the seller under the setoff provision in the note.

The lawsuit

The seller sued the buyer in a New York state court to recover the balance due on the note. The buyer defended itself saying that it had the right under the note and purchase agreement to setoff its damages against the note payments and withhold those amounts from the seller.

The trial court agreed with the buyer.

This case is referred to Borremans v. Gardner, Docket No. 651772/2018, Motion Seq. No. 001, Supreme Court, New York County, (March 18, 2019) https://scholar.google.com/scholar_case?case=16415870042329832312&q=%22membership+interest+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017

Comment

A buyer often wants the right to setoff any loss the buyer suffers arising out of the seller’s breach of the acquisition documents against any obligations owing to the seller under a note or other obligation such as payments for a noncompetition covenant.

The seller often resists; especially on the grounds that the buyer should not have the power to decide if the seller breached the purchase agreement. A common compromise is a requirement that the buyer can’t exercise a setoff right if the seller denies the breach until the matter has been resolved in binding arbitration. However, the buyer may not agree because there might not be much deferred payments available by the time the dispute is resolved by arbitration.

By John McCauley: I help businesses minimize risk when buying or selling a company.

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 asset purchase agreement, financial representation and warranty, membership interest purchase agreement, offset or setoff provision, offset right, promissory note, representations and warranties Tagged with: , ,

Buyer blows merger extension deadline, fights $126 million breakup fee

Introduction

A seller of a business may want the right to terminate a deal if a more attractive offer comes along; especially if the seller is a public company.  The buyer will often agree to this provided that the seller pays a breakup or termination fee to compensate the buyer for its time, expense and lost opportunity.

On the other hand, a buyer, especially a private equity firm, may want a right to terminate a deal, especially if the buyer cannot get financing. The seller might be agreeable but then may want the buyer to pay the seller a “reverse” breakup or termination fee to compensate it for its time, expense, taking the seller off the market, and upsetting the seller’s relationships with its market, vendors and employees.

The breakup fee or reverse breakup fee can be a big number.

The deal

In this case the buyer agreed to buy out the seller for $1.38 billion pursuant to a merger agreement. Both buyer and seller are both large chains of rent to own stores; and so, the closing of the deal was conditioned upon working out antitrust issues with the federal government.

The merger agreement had a closing deadline. However, the deal might not be ready for closing by the deadline considering the complex antitrust issues. So, the buyer had a right to extend the deadline by giving the seller timely notification. If the buyer did not give timely notification, then seller had the right to cancel the deal and claim a $126.5 million reverse breakup fee.

The parties worked with the federal government to resolve the antitrust issues. Nevertheless, the deadline passed while working on the antitrust issues. The buyer did not give the seller timely notice of buyer’s election to extend the deadline. The seller then cancelled the deal and demanded the $126.5 million reverse termination fee.

The lawsuit

The buyer went into a Delaware court to challenge the seller’s cancellation. The buyer did not deny that it had not sent a timely extension notice. However, the evidence was clear that the seller knew that the buyer had not backed out of the deal.

Nevertheless, the court held that the buyer had not given a timely extension notice and that failure had consequences. However, the court left for another day whether the seller was entitled to the $126.5 million reverse breakup fee saying that it questioned “whether the parties considered this scenario in contracting for the reverse break-up fee.”

The court asked the parties to brief the court on whether the fee must be paid considering the unusual fact situation and Delaware’s implied covenant of good faith and fair dealing doctrine.

This case is referred to Manfre v. May, No. 1:18-cv-2184, United States District Court, N.D. Illinois, Eastern Division, (March 12, 2019)

Comment

The Delaware Court of Chancery did not like the seller’s behavior or the outcome of the case. The court observed that the buyer was surprised by the seller’s termination of the contract; and pointed out that the buyer had expended six months of effort and considerable funds toward closing. The court was sympathetic to the buyer saying that it was understandable that the buyer was angered by the seller’s “sharp practice.”

Nevertheless, the contract’s requirement to give a timely extension notice was not what the pirate Captain Hector Barbossa in the first “Pirates of the Caribbean” film had in mind when talking about the pirate code: “more what you’d call guidelines than actual rules.”

The court also did not like the size of the reverse breakup fee, calling it “enormous.”

By John McCauley: I help businesses minimize risk when buying or selling a company.

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 extension of closing, implied covenant of good faith and fair dealing, merger, reverse termination or breakup fee, termination of M&A agreement, termination or breakup fee Tagged with: , , , , ,

S Corp Stock Seller Can Sue Buyer for Not Closing Tax Books Mid-year

Introduction

An S corporation does not pay federal corporate income tax. The S corporation passes its income, deductions and credits through to its shareholders, in proportion to their ownership interest in the S corporation. The shareholders then pay income tax on those tax attributes.

Most S corporations have a calendar taxable year. So, what happens if a S corporation shareholder sells his stock during the middle of the year?

Generally, the S corporations’ income, deductions and credits for the calendar year of sale is prorated. In other words, if the deal closed at the end of June, a 50% selling shareholder would receive 25% of the S corporation’s tax attributes because it owned ½ of the company for ½ of the year.

But what if the company had a loss as of the date of sale and the selling shareholder expected the company to end up with a substantial profit by year end? In that case, under the federal tax laws, the S corporation could close the books on the date of sale. There would be two taxable years. And the selling Shareholder would be allocated a share of the S corporation’s pre-sale loss.

However, for that to happen, all the shareholders, both pre and post-closing would have to consent to what is called an Internal Revenue Code or IRC section 1377 election. If the election is not made then the selling shareholder just takes his or her prorated share of the S corporation’s income, deductions and credits for the calendar year.

The deal

This case involved those facts. The selling shareholder sold his stock to the remaining shareholders at the end of the 2009 first quarter (March 31) pursuant to a stock purchase agreement. If the books were closed then, the selling shareholder would have been allocated a $31K loss from the S corporation.

After the closing, the selling shareholder requested that the other shareholders consent to closing the tax books as of March 31 by consenting to the S corporation making the IRC section 1377 election. Two of the buying shareholders refused.

At year end the selling shareholder was allocated $143K of prorated S corporation income for 2009.

The lawsuit

The selling shareholder sued the two buying shareholders in an Illinois federal district court for $85K in federal and state income taxes it was required to pay, because the two buying shareholders did not consent to the section 1377 election. The selling shareholder based his suit on a boilerplate provision in the stock purchase agreement where the buying shareholders promised to “execute and deliver all … instruments and take all … actions as” the selling shareholder “may reasonably request … in order to effectuate the purposes of” the stock purchase agreement. In the trade this boilerplate provision is called a “further assurance” provision.

The buying shareholders asked the court to dismiss the lawsuit arguing that the further assurance provision does not obligate the buying shareholders to consent to closing the tax books of the S corporation at the end of the 2009 first quarter (consent to the IRC section 1377 election).  The court would not dismiss the lawsuit saying that the selling shareholder’s argument was “plausible”; which was good enough for the court.

What does that mean? The selling shareholder’s get’s a chance to continue its lawsuit.

This case is referred to Manfre v. May, No. 1:18-cv-2184, United States District Court, N.D. Illinois, Eastern Division, (March 12, 2019)

Comment

It seems like a stretch that the further assurances provision obligates the buying shareholders to consent to the section 1377 election.

The lesson here is to have your tax adviser look at the deal before the parties have agreed to the key business terms in case there is an important tax provision that you want. That means before you sign a letter of intent; and of course, long before you sign a definitive acquisition agreement.

In this case, had you decided after consultation with your tax adviser that you wanted a section 1377 election; then make sure that the purchase agreement requires all shareholders to consent to an Internal Revenue Code section 1377 election.

By John McCauley: I help businesses minimize risk when buying or selling a company.

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 allocation of preclosing taxes refunds and credits, boilerplate provisions, further assurance provision, Internal Revenue Code Section 1377 election, purchase agreement, stock purchase agreement Tagged with: , , ,

Asset Purchase of Spa Shields Buyer from Seller Employee Claim

Introduction

You want to buy an existing business. You select your target business, a purchase price and payment terms. Now what?

You talk to your accountant, lawyer or other adviser about how to do the deal. Your adviser asks you if the business is operated as a corporation or LLC (limited liability company). You say that it is a corporation or LLC.

That leads to a discussion of managing the risk of doing the deal.  And usually the first risk management issue in doing a deal is whether you will buy the assets of the business from the corporation or LLC or buy the stock of the corporation (or equity of the LLC).

What do you do? Well, buying stock means that you get all the company’s assets; but you also get all the company’s liabilities. If you buy the assets of the business, you can pick and choose which assets you want and which liabilities you will assume (subject to some significant exceptions).

The deal

In this case a couple wanted to buy an existing spa business that was conducted as a corporation. They formed a corporation and purchased the assets of the spa and assumed only certain of the spa’s liabilities that were described in the asset purchase agreement.

The deal closed in November 2013.

The lawsuit

After the closing a former employee of the seller corporation sued the buyer and the seller’s owner in a New York state court. The employee claimed that she was sexually assaulted by seller’s owner in May of 2013.

The buyer asked the court to throw out employee’s claim against the buyer in a motion for summary judgment. The buyer proved it was formed and purchased the spa 5 months after the alleged sexual assault; and the asset purchase agreement’s description of the seller liabilities assumed by the buyer did not include any liability to the employee. Furthermore, the buyer stated that neither the buyer nor its owners ever had an interest in the seller corporation; nor did the seller corporation or the seller owner have any interest in the buyer corporation.

The employee offered no evidence to counter buyer’s proof other than a reference in the first paragraph of the asset purchase agreement to the seller’s owner as the buyer. The court was not impressed with what was probably a typographical error, noting that the buyer corporation clearly signed the asset purchase agreement as the buyer, and the bill of sale clearly transferred the spa assets to the buyer.

The employee argued that it should be permitted to continue the lawsuit so it could conduct more discovery to see if the seller’s owner had some interest in the spa business owned by the buyer. The court said no and threw out the employee’s claim against the buyer.

The court concluded that the evidence provided by the buyer clearly established that the buyer purchased the assets of the spa long after the alleged assault; and the buyer did not assume the seller’s liability to the employee.

This case is referred to Wilkow v. Araque, Docket No. 154300/2014, Motion Seq. No. 002, Supreme Court, New York County, (March 11, 2019) https://scholar.google.com/scholar_case?case=6871192005474678056&q=%22asset+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017.

Comment

In addition, the court granted the buyer $2,500 as sanctions against the employee’s lawyers for filing a frivolous claim against the buyer.

The buyer owners also managed this risk by forming a corporation to buy the assets. Otherwise, the buyer owners would have exposed their personal assets to the employee’s lawsuit.

By John McCauley: I help businesses minimize risk when buying or selling a company.

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 purchase agreement Tagged with: , ,

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