Entrepreneur: Be Fair to Your Other Owners When Selling Your Company

Introduction

You started your company. As you grew you issued stock to key employees or issued stock to investors to raise capital.

The company grew under your management. You are the CEO of the company, a board member, and as majority shareholder, you control the board of directors.

You are approached by a company that wants to buy you out. The buyer offers you a so-so price for your company. But the buyer wants you to run the business for the buyer. And the offer includes a very lucrative compensation package consisting of a seven-figure retention bonus, a base salary much larger than your current base salary, and equity incentive compensation with great upside potential.

You like this deal and want to take it. Does this present any legal problems?

In short yes. When selling your company, as a board member, controlling owner, and officer, you must take efforts to achieve the highest value reasonably attainable for the other owners. Failure to do so breaches your duty of loyalty and your duty of due care to the other owners

The deal

In this recent case, the company was sold for $1.3 billion.  The buyer’s original $20 per share offer was rebuffed by the company’s officers and board. Later, the officers and board agreed to a $21.50 pers share price. In the accepted deal, the buyer would retain the company’s current officers and directors.

As part of the deal senior management and the company’s board member would receive six and seven figure cash out payments for equity awards, including Target’s CEO $4.9 million cash out payment. Furthermore, retention bonuses would be paid 3 years after the closing. $5.5 million for Target’s CEO and $1.25 million each for the other four officers.

The lawsuit

Even before the deal closed, a shareholder demanded to see the company’s books and records about the deal, including any personal emails of the company’s officers and directors. The company denied the request and the stockholder went into a Delaware court to obtain the books and records.

The shareholder wanted to investigate whether the company stockholders had been underpaid by the buyer because the officers and directors had breached their duties of due care and loyalty owed to the shareholders. Specifically, the stockholder was concerned that the officers and board members took buyer’s deal not because of the purchase price was the highest value reasonably attainable but because of the generous compensation buyer agreed to pay to retain them as officers and directors of the company after the closing.

The stockholder argued that the board and officers may have gotten a better price either with buyer or another suitor. However, the stockholder said that the officers and directors did not explore other potential suitors. Furthermore, the stockholder suspects that management’s projections that were used by the company’s investment banker to evaluate buyer’s offer, were too low; ignoring very promising future revenue on a significant project.

The court ordered the company to produce the books and records including the relevant personal emails of the company’s officers and directors. The court noted that the stockholder did not have to offer much evidence in support of its books and records request.

This case is referred to Inter-Local Pension Fund GCC/IBT v. Calgon Carbon Corporation, C.A. No. 2017-0910-MTZ, Court of Chancery of Delaware, (Decided: January 25, 2019).

Comment

The court’s order to the company to produce the books and records does not mean that the board or management did anything wrong. It just gives the stockholder the right to investigate to see if any wrongdoing occurred.

Remember: if you control a company that has other owners; treat them fairly. There are legal consequences to you if you don’t.

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.

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Buyer and seller fight over calculation of net income earnout

Introduction

Sometimes a seller of a business will agree to take a portion of the purchase price based upon the future performance of the business. This part of the purchase price is called an earnout. The calculation of the earnout is based upon a formula that is contained in the written purchase agreement.

Earnouts are risky for the seller because the future performance of the business depends upon the buyer – not the seller. Also, the seller runs the risk that the buyer (who controls the business books and records) will cook the books to avoid or reduce the earnout.

The deal

In this case the buyer purchased seller’s interest in a limited liability company effective the beginning of 2016. Part of the purchase price was an earnout of 50% of the company’s net income allocated to buyer for 2016 through 2018.

The lawsuit

The seller sued the buyer in a Pennsylvania federal court claiming that the buyer underpaid seller’s 2016 and 2017 earnout.

The seller claimed that the buyer underpaid him partly by deducting as expenses fees paid to affiliates of the company, that were owned in part by the buyer.  The seller pointed to the formula for net income contained in the purchase agreement which did not allow these fees to be included as expenses for calculation of the net income earnout. The court agreed.

The seller also claimed that the buyer did not include all the company’s revenue in the calculation of the net income. Specifically, that buyer did not include revenue that was earned by the company but not received by the company.

The court did not buy this argument. It noted that revenue was described in the purchase agreement as revenue earned by the company. But this language was later followed by language that said for purposes of the purchase agreement revenue would be recognized when received by the company.

This case is referred to Warren Hill, LLC v. SFR Equities, LLC, Civil Action No. 18-1228, United States District Court, E.D. Pennsylvania, (February 8, 2019).

Comment

The formula for the earnout used in the purchase agreement worked. The court was able to resolve the two disputes about calculation of the net income by referral to the formula.

In 20/20 hindsight, to avoid this fight, the seller and the buyer could have agreed to a fixed purchase price to eliminate a later fight over the amount of the earnout.

Even moving up the income statement for an earnout formula based not on net income but revenue would eliminate any fights over expenses.

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.

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Boilerplate in business purchase agreement – good for insomnia, but may be important in a post-closing fight

Introduction

Reading boilerplate in a business purchase agreement helps me sleep. The language is a tough read. But beneath the dense language are words that can really matter when a fight breaks out after the closing.

The deal

The buyer purchased all stock of the seller’s company.

The buyer and the company promised in the stock purchase agreement that the company was exclusively responsible for the company’s debts after the closing. The provision went on to say that the company would indemnify the seller if the seller got stuck with any company debt.

The lawsuit

After the closing a large auto financial company sued the company, the seller, and the buyer for breach of the company’s lease and loan documents in a Pennsylvania federal court.

The seller filed a claim against the company and buyer.

The buyer pointed to the stock purchase agreement and said only the company was responsible for this debt. Meaning, the seller can only sue the company not the buyer.

The court looked at the stock purchase agreement and agreed with the buyer.

This case is referred to Mercedes-Benz Financial Services Usa LLC v. Synergistiks, Inc., Case No. 3:18-cv-184, United States District Court, W.D. Pennsylvania, (February 12, 2019). https://scholar.google.com/scholar_case?case=14685828736300095129&q=%22stock+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017

Comment

A buyer of a company does not want to be sued for any of the company’s liabilities unless the buyer voluntarily guarantees a company liability in writing.

A seller of a company’s stock does not want to be responsible for the company’s debt after the seller signs over the seller’s stock certificates to the buyer.

Therefore, the seller will want the company to promise in writing to reimburse the seller if the seller gets stuck with any company debt after the closing.

In a home run, the seller would want the buyer of the company to also promise to reimburse the seller for any company debt the seller pays after the closing.

In this case the seller could have sued the buyer if the boilerplate provision said that the company and the buyer would reimburse the seller for any company debt the seller pays after the closing.

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.

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Worst case – buying a business with a large unknown liability

Introduction

One of the biggest risks in buying a business, car or house is the unknown problems that pop up after the purchase. This case illustrates the problem.

The deal

Buyer purchased all the stock of a company from sellers.

Sellers promised in the stock purchase agreement that the company had not guaranteed the debt of any other company.

The unknown liability

Prior to the closing, this company had guaranteed the debt of another company.

Buyer did not know about this guaranty before buyer purchased the company.

The lawsuit

After the closing the other company defaulted on the debt. The creditor sued its debtor, the company buyer purchased, as guarantor of the debt, and the buyer. An Alabama federal court said that creditor had a legitimate claim against buyer to reach funds buyer had received from the purchased company, the guarantor of the debt.

The buyer may lose those funds to the creditor. Buyer can hopefully recover its loss from the sellers of the company it bought. with a claim against sellers for their broken promise that there were no company guarantees.

This case is referred to Hiring Automation, LLC v. Simple Onboard, LLC, Case No. 4:18-CV-773-KOB, United States District Court, N.D. Alabama, Middle Division, (January 30, 2019).

Comment

When you buy the stock of the company you buy not only the dog but its fleas. Meaning: you buy not only the assets of the company but all its liabilities, even those unknown to you at the closing.

What can you do about this risk?

1. Kick the tires (due diligence). However, in this case the court said that at least one of the sellers knew about the guaranty and hid it from the buyer.

2. Get seller to promise in the written agreement to cover your losses if an unknown loss crops up after closing.

3. Or, buy the assets of the company and not assume any unknown liabilities. This generally works, with some exceptions.

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.

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Hawaii federal court says that seller of convenience stores cannot discharge his deal fraud liability in bankruptcy

Corporate entities controlled by Seller sold a chain of convenience stores and related assets to corporate entities controlled by Buyer. This sale was governed by a stock purchase agreement. The stock purchase agreement required that Seller submit a working capital estimate to Buyer, which would determine the amount of cash Buyer would have to pay Seller at closing. Buyer thought the working capital estimate Seller submitted was much too low. Thus, Buyer refused to pay Seller additional money.

Seller filed suit against Buyer in state court to compel him to pay money Seller believed he was owed under the stock purchase agreement, and Buyer counterclaimed, alleging, among other things, that Seller’s low working capital estimate was the result of Seller’s fraud.

Following the trial, the trial court entered a written order finding that the low working capital estimate was a result of Seller’s fraud, and that Seller had committed fraud because the stock purchase agreement set up an arrangement making Seller “Construction Manager” of certain projects, which Buyer had to pay him for, but Seller had no intention of ever serving as “Construction Manager” or doing anything that might entitle him to that money. The trial court awarded Buyer approximately $150 million in damages, of which approximately $85 million was compensatory damages for Seller’s fraud in the inducement—inducing Buyer to enter into the transaction with Seller to buy Seller’s company.

Buyer and Seller subsequently agreed to settle their dispute. Under the settlement agreement Seller agreed to execute a confession of judgment in the amount of $85 million that Buyer could file with the state court (and thus make enforceable) without prior notice to Seller, in the event Seller defaulted on his payment obligations under the settlement agreement. The confession of judgment included the portions of the state court’s written order following trial finding that Seller committed fraud.

Seller defaulted on his obligations under the settlement agreement when Seller failed to make a required $4 million payment on time. Seller then asked Buyer to hold off on enforcing Buyer’s rights under the settlement agreement to give Seller more time to come up with the money. Buyer agreed, and the parties entered into a forbearance agreement. But then Seller also defaulted on the forbearance agreement.

After Seller defaulted on the forbearance agreement, Buyer filed the confession of judgment in state court. The clerk of the state court entered the judgment against Seller for $85 million, and the state court found the confession of judgment complied with applicable state law. The Nevada Supreme Court denied Seller’s challenges to the confession of judgment.

Shortly thereafter, Buyer, as a creditor of Seller, filed an involuntary bankruptcy petition against Seller. Buyer then filed a complaint against Seller in bankruptcy court seeking to establish that the $85 million confession of judgment against Seller was nondischargeable in bankruptcy. The bankruptcy court agreed with Buyer finding that the $85 million debt was nondischargeable under the bankruptcy law because it was a debt incurred as a result of fraud. Seller appealed to the federal district court and lost there too.

This case is referred to In Re Morabito, Case No. 3:18-cv-00221-MMD, United States District Court, D. Nevada, (January 22, 2019).

Comment. Committing fraud when selling or buying a business is more serious than simply breaching the terms and conditions of the purchase agreement. If there is fraud the other party may be able to recover damages well in excess of any negotiated indemnification cap on damages contained in the purchase agreement.

Furthermore, the party committing fraud may not be able to discharge the fraud liability in bankruptcy.

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.

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Case demonstrates the risk of a seller of a business runs in agreeing to deferred purchase price in form of royalties

Between 1987 and 1999, Seller developed two software products. Both programs were designed to assist pharmaceutical companies and other related industries regulated by the Food and Drug Administration to comply with reporting and record-keeping obligations.

Buyer was founded in 1997 and was still a start-up company with one viable product, which was substantially similar to one of Seller’s software products, when Buyer executives approached Seller about developing and selling Seller’s software. Ultimately, on February 23, 1999, Buyer and Seller entered into an asset purchase agreement by which Buyer purchased Seller’s software. Under the terms of the asset purchase agreement, Seller was to receive a percentage of future sales and royalty payments.

In 2001, according to Seller, Buyer executives persuaded him to amend the asset purchase agreement by implying that Buyer would develop its own version of one of Seller’s software products unless Seller cooperated and agreed to amend the asset purchase agreement. He was informed that one of Seller’s software sales were low and that most of the revenue came from the sale of Buyer’s software and not Seller’s software. The asset purchase agreement, as amended, further reduced Seller’s royalty payments.

In 2003, Buyer and Buyer’s New Owner announced that Buyer’s New Owner was in the process of acquiring Buyer’s stock, and that transaction closed in early 2004. Shortly after the closing, in February of 2004, Seller sent an email to Buyer, accusing Buyer of underpaying him in an amount Seller estimated to be in the low seven-figure range, plus interest.

Seller’s email attributed the underpayments to intentional fraud and a Buyer executive team and sales force that had a bad reputation with Buyer’s customer base. Seller claimed that the problems with Buyer’s organization were never disclosed to Buyer before he sold Buyer his software.

Payments continued at much lower levels than Seller expected, and Seller’s request of Buyer for an explanation went unanswered. Finally, in 2006, Buyer’s New Owner conducted an internal audit, which revealed that Buyer had used certain tactics to boost sales of Buyer’s software product to Seller’s detriment. The audit also disclosed that Buyer’s New Owner would have to change certain practices to fully comply with the asset purchase agreement. However, nothing changed, and the dispute between Seller and Buyer’s New Owner continued.

Eventually, in October of 2008, Buyer and Seller executed an agreement tolling the statute of limitations relating to Seller’s claims. Soon after the tolling agreement was signed, Buyer’s New Owner provided Seller with 4,000 pages of sales records covering the period from 1999 to 2004. According to Seller, these records demonstrated that Buyer fabricated Buyer’s software sales and gave away free or unlicensed copies of Seller’s software. Seller claimed that that the sales records disclosed that Buyer fraudulently recorded Seller’s software product customers as having paid for purchases of Buyer’s software that the customers did not want or need. Buyer also sold copies of Seller’s software to numerous customers, but falsely designated those as sales of Buyer’s software. In addition, Buyer inflated Buyer’s software’s sales to fabricate demand for Buyer’s software and deprive Seller of sales royalties from software. And, Buyer failed to develop or sell one of Seller’s software products.

Seller asserted that Buyer’s New Owner continued these same sales and reporting practices after it acquired Buyer. Ultimately, on September 23, 2016, Seller sent Buyer’s New Owner a lengthy demand letter, which included an offer to settle the claims.

The demands were not met, and the offer to settle was declined. Seller then sued Buyer in a Massachusetts state court for fraud.

Seller lost his lawsuit against Buyer for allegedly making fraudulent promises during 1998/1999 negotiations of the Seller/Buyer deal concerning the payment of royalties and in failing to disclose the alleged bad reputation Buyer’s executive team and sales force had with Buyer’s customer base. Seller lost this fraud claim because he waited too long. Seller had 3 years to sue after he discovered the alleged fraud, and trial court concluded that Seller discovered the fraud around February of 2004. Seller appealed and the trial court’s decision was upheld by the appellate court.

But, Seller’s claims for Buyer’s post-closings misrepresentations were not dealt with by the state court. Instead they were transferred to a Massachusetts federal district court for resolution.

This case is referred to Kelly v. Waters Corporation, No. 18-P-58, Appeals Court of Massachusetts, (February 15, 2019).

Comment. This case demonstrates the risk a seller of a business runs when it takes a portion of the purchase price in the form of an earnout or royalty. In that case the seller is relying on the buyer to make his earnout or royalty. The risk is that the buyer is not motivated to do so or is willing to manipulate the books to minimize the payout, or both.

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.

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Buyer’s purchase price adjustment mechanism based upon a post-closing inventory audit survives seller challenge in court

Seller was a distributor of compressed gases and welding supplies in Indiana. Seller sold substantially all of its assets to Buyer including its stock of asset cylinders, pursuant to an October 2014 asset purchase agreement. As part of the asset purchase agreement, Buyer paid Seller $1.6 million for Seller’s assets, of which the primary assets were its asset cylinders.

Seller rented the asset cylinders to businesses in need of compressed gas for use in their operations, including restaurants or convenience stores which rented carbon dioxide cylinders for soda fountains that must then be refilled on a regular basis. As a result, a critical factor in determining the appropriate price for the sale of Seller’s assets was the number of asset cylinders that could be transferred.

The sales price was based in part on Seller’s representation that there were approximately 6,500 cylinders. Buyer and Seller could not ascertain a precise count of the cylinders that would be transferred at the closing because many cylinders were “out in the field” with customers. Therefore, the asset purchase agreement provided that Buyer would conduct a post-closing audit of the cylinders.

The agreement purchase agreement further called for a purchase price adjustment based upon the post-closing audit of the cylinders. The purchase price would be increased if the audit found more than 6,500 cylinders at the rate of $125 per cylinder; or decreased at the same rate to the extent the audit found less than 6,500 cylinders.

Buyer’s risk that the Seller’s cylinder inventory was between 5,300 and 6,500 cylinders was secured by Buyer holding back $150K of the purchase price. Buyer had to complete the audit by April 15, 2015. The audit took longer than planned and Seller orally agreed to extend the audit and it was completed on May 22, 2015, before expiration of the extended deadline.

The audit found that Seller had under 4,700 cylinders; well below the Seller’s representation of approximately 6,500 cylinders. Furthermore, Buyer’s $150K holdback of the purchase price protected Buyer for part of the shrinkage, leaving Buyer exposed to a loss of about 700 cylinders at $125/cylinder (that is, the difference between Buyer’s loss down to 5,300 cylinders and the number of cylinders the audit said Buyer purchased from Seller; approximately 4,700 cylinders).

As a result of the audit Buyer kept the $150K holdback. Seller sued Buyer in an Indiana federal district court for the $150K holdback. Buyer counterclaimed saying that it should not only keep the $150K of held back purchase price but Buyer was also entitled to receive damages for the additional 600-cylinder shortfall computed at the rate of $125/cylinder. The trial court agreed with Buyer and Seller appealed.  Seller also lost on appeal.

This case is referred to Arc Welding Supply Co., Inc. v. American Welding & Gas, Inc., No. 18-1546, United States Court of Appeals, Seventh Circuit., (Decided February 14, 2019).

Comment. Purchase price adjustments are commonly used. In this case the real unknown at closing was the number of Seller’s cylinders; cylinders being a major value factor for the business. An inventory audit after the closing helped determine the correct purchase price.  And securing the risk that Seller’s inventory level representation and warranty was optimistic with a Buyer $150K holdback of the purchase price helped minimize Buyer’s exposure to that risk.

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

Email: jmccauley@mk-law.com

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

Telephone:      714 273-6291

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.

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Seller of auto dealership franchise sues auto maker for violation of state’s auto dealer law regulating consent to franchise sales

Seller owned a GM automobile dealership in Pennsylvania since 1985. In 2016, Seller began exploring the sale of Seller’s assets to potential buyers. Seller subsequently began negotiations with Buyer, who owned and operated several GM dealership line-makes in the state.

In the fall of 2016, Seller and Buyer agreed that Buyer would purchase Seller’s assets. As part of the purchase, Buyer planned to effectively close Seller’s Buick franchise and consolidate it with Buyer’s existing Buick franchise dealership. Buyer also planned to relocate the GMC Truck franchise to Buyer’s dealership.

On November 17, 2016, Seller and Buyer entered into a written asset purchase agreement where Buyer agreed to purchase all of Seller’s new vehicles and new parts inventory and goodwill for $750,000.

As required by Seller’s dealer franchise agreement with GM, closing on the sale was conditioned upon GM’s approval of the sale to Buyer, and upon GM’s approval of the relocation of the GMC Truck dealership to the Buyer’s dealership facility. Seller notified GM of the proposed sale to Buyer and Seller and Buyer submitted the November 2016 asset purchase agreement and all required forms for GM’s consideration by January 20, 2017, except for Buyer’s pro forma balance sheet for which Buyer needed GM to provide the capital requirements.

Over the course of the next several weeks, GM made multiple requests to Buyer for additional information relative to GM’s application and approval process, including a criminal background check of Buyer’s owner. All requested information was provided to GM. During this same period, Seller contacted GM on multiple occasions to inquire as to the status of GM’s approval process. Seller advised GM that, as word of the proposed sale was becoming known, Seller was losing customers and key employees, and that Seller had little inventory to sell. Thus, Seller advised GM that monthly operating losses were mounting.

On April 19, 2017, GM issued a letter to Seller, with a copy to Buyer, advising that GM refused approval of the November 2016 asset purchase agreement.  Although Seller and Buyer disagreed with GM’s decision, on June 27, 2017, Seller and Buyer entered into a new and revised asset purchase agreement for the sale of Seller dealership assets. The substantive terms of the November 2016 asset purchase agreement and the June 2017 asset purchase agreement were essentially the same, with two material exceptions: (i) the June 2017 asset purchase agreement no longer contemplated the relocation of Seller’s dealership assets to the Buyer’s dealership facility; and (ii) the purchase price for the value of Seller’s dealerships was reduced from $750,000 to $600,000.

The June 2017 asset purchase agreement was forwarded to GM on June 27, 2017. On September 5, 2017, GM approved the June 2017 asset purchase agreement.

After the closing Seller sued GM in a Pittsburgh federal district court. Seller claimed that it lost $150,000 on the sale of the goodwill (blue sky) value of its Buick and GMC Truck dealerships to Buyer; and in excess of $850,000 as a direct result of GM’s actions in denying the proposed sale to Buyer through the November 2016 asset purchase agreement and its further delay in processing the June 2017 asset purchase agreement.

GM asked the court to dismiss the claims on the grounds that Seller’s factual allegations, if true, were not enough to make out legal claims against GM. The court agreed with GM.

The court said that the primary question in deciding a motion to dismiss was not whether Seller would ultimately prevail, but rather whether Seller was entitled to offer evidence to establish the facts alleged in the complaint. The purpose of a motion to dismiss being to streamline litigation by dispensing with needless discovery and factfinding.

In this case the court said that Seller had not made out allegations of a legal claim; but permitted Seller to amend its complaint with additional factual allegations.

Seller had accused GM of violating Pennsylvania’s auto dealer law because GM delayed in responding to a request for consent to the terms of the November 2016 asset purchase agreement. This law is a comprehensive statute governing the relationship between automobile manufacturers and their franchise dealers.

The court said that GM would violate this law if GM failed to respond in writing to Seller’s request for consent to a sale of Seller’s franchise to Buyer within 60 days of receipt of a written request on the forms generally utilized by GM for such purposes and containing the information required. Furthermore, if GM required additional information to complete its review, GM should have notified Seller within 15 days of the receipt of the forms. In no event should the total time period for GM’s approval exceed 75 days from the date of the receipt of the initial forms.

However, the court found that Seller was not clear when all required forms were submitted to GM; meaning that it was not clear when GM’s had to either timely request more information, deny or consent to the transfer. Specifically, Seller alleged that on January 20, 2017, Seller and Buyer notified GM that they had completed all the electronic application forms, except for the pro forma balance sheet, for which Buyer was waiting for GM to provide it with the capital requirements necessary to complete the pro forma balance sheet. Thus, Seller still had not submitted all information on the forms that it was required to provide.

Given the absence of specific dates for when the final forms, containing the information required, were submitted, the court concluded that Seller had not pleaded with enough specificity to permit calculation of the deadlines for GM’s response. However, the court said Seller could fix this problem by amending its complaint.

GM next argued that Seller failed to sufficiently state its claim for $850,000 in damages, associated with GM’s denial of the November 2016 asset purchase agreement. Under Pennsylvania’s dealer law, GM can’t unreasonably withhold consent to Seller’s sale of its franchise to Buyer if Buyer was capable of being licensed as a new GM dealer under reasonable requirements for appointment as a dealer.

Seller alleged that Seller’s sustained $850,000 in damages resulting from the rejection of the November 2016 asset purchase agreement. GM argued that Seller offered only conclusory assertions that it lost in excess of $850,000 as a result of GM’s actions in denying the proposed sale. GM said that Seller did not allege facts to support its damages assertions or identify any grounds for its purported loss.

The court decided that Seller’s complaint lacked specific factual allegations to identify what comprised the $850,000 claim or how such damages relate to GM’s alleged unreasonable withholding of consent of the November 2016 deal. Accordingly, the court dismissed this claim, but Seller was permitted to amend its complaint with more specific allegations.

This case is referred to Brooks Automotive Group, Inc. v. General Motors LLC,  No. 2:18-CV-00798-MJH, United States District Court, W.D. Pennsylvania, Pittsburgh, (February 5, 2019). https://scholar.google.com/scholar_case?case=4437674053633974867&q=%22asset+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017

Comment. Often the acquisition of a business cannot close without the consent of a third party. This is generally true when purchasing a franchised business, and especially an auto dealership.

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

Email: jmccauley@mk-law.com

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

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Posted in asset purchase agreement Tagged with: ,

Inventor of product sues seller of product for unauthorized use of inventor’s name for commercial purposes

Inventor has a Ph.D. in physical pharmacy and specializes in the formulation of topical creams for various health and wellness needs. He is the CEO of Seller and the public face of the company throughout the pharmaceutical industry. In April 2012, Buyer engaged Seller and Inventor to develop a topical cream used to treat men with sexual dysfunction. Under the agreements between Seller and Buyer, Seller and Inventor formulated a commercial product and assigned all their rights to the invention to Buyer. As a result of their partnership, Buyer launched the product on April 13, 2013.

On April 19, 2013, Buyer and Current Seller entered into an asset purchase agreement under which Current Seller acquired the global rights to market the product, and Buyer retained the right to commercialize the product in the United States. Current Seller commercialized the product under a different trade name.

Inventor claimed that although Inventor never gave permission to Current Seller to use his name, image, identity, or likeness in connection with the product, Current Seller marketed the product with Inventor’s name and implied endorsement. Specifically, Inventor alleged Current Seller circulated advertisements and marketing materials in newspapers, magazines, pamphlets, and on social media sites; suggesting, implying, and/or outwardly stating that Inventor endorsed the product. Further, Inventor alleged that some of these publications falsely attributed quotes to Inventor, placed Inventor in a false light, and falsely claimed Inventor offered a satisfaction guarantee on the product.

Inventor sued Current Seller in a Chicago federal district court for reputational harm suffered as a result of Current Seller’s use of Inventor’s name in its advertising program. Inventor accused Current Seller of the unauthorized use of Inventor’s identity for commercial purposes in violation of Illinois publicity law (the Illinois Right of Publicity Act), federal trademark law and the Illinois false light law.

Current Seller moved to dismiss the complaint arguing that Inventor would have no legal claim against it even if Current Seller’s had used Inventor’s name in its advertising program in the manner alleged by Inventor. The court disagreed and denied Current Seller’s motion to dismiss. In another words, Inventor, if it can prove it, has a claim against Current Seller.

This case is referred to Yeager v. Innovus Pharmaceuticals, Inc.,  No. 18-cv-397., United States District Court, N.D. Illinois, Eastern Division, (February 5, 2019).

Comment. With 20/20 hindsight Inventor should have made sure that Buyer promised in the assignment agreement between Seller and Buyer, not to use Inventor’s or Seller’s name for commercial purposes; and to promise to prohibit by written agreement any Buyer licensee, buyer or assignee of the product from using the names of Inventor or Seller for commercial purposes.

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

Email: jmccauley@mk-law.com

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

Telephone:      714 273-6291

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.

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Health club buyer fights with seller’s landlord over ownership of some health club assets

Seller operated a health club in Georgia. It leased the building from Landlord.

Seller ended up in financial trouble, filed for bankruptcy and sold its assets out of bankruptcy to Buyer. Buyer did not lease Landlord’s building. After the closing, Buyer started removing the health club’s assets.

Landlord went into bankruptcy court to stop Buyer from removing the health club’s lockers, mirrors, a nonmovable and freestanding sink, and T.V. stands. Landlord claimed that it owned those assets.

The court agreed that Landlord owned the mirrors glued to the walls and lockers affixed to the walls located in the new edition of the club, noting that Landlord owned those assets because it installed the lockers and these mirrors when it built a new edition to the health club.

As to the sinks, a juice bar was installed by a third-party planning to operate a juice/smoothie bar for the gym patrons. The third party ultimately backed out of the venture. Seller allowed the third party to leave the juice/smoothie bar with Seller in return for Seller not taking any action against the third party. There were two sinks associated with the juice bar. One sink was built into the cabinets; and the other was a plastic freestanding sink on 4 legs which was attached by plumbing for hot and cold water and a drain but was easily removable.

Landlord claimed that both sinks were fixtures and that under the lease, Landlord owned the fixtures. The court agreed with Landlord as to the nonmovable sink which was built into the health club cabinets because it was more permanent and was a fixture, even if installed on behalf of Seller by a third party.

On the other hand, the court awarded the freestanding sink to Buyer because it was not a fixture given its ease of detachment, and no evidence that removal would damage Landlord’s building. Same for the T.V. stands.

There were other mirrors in the old edition of the health club. No one knew who installed them. Landlord said they were wall coverings and under the health club lease Landlord owned the wall coverings. The court disagreed and said that they were trade fixtures which under the lease belonged to Seller as tenant, (which Buyer purchased from Seller). They were trade fixtures because the mirrors were easily removable without causing substantial damage to Landlord’s building.

This case is referred to IN RE SCIENCE FITNESS, LLC,  Case No. 14-12297, Adversary Proceeding No. 16-01035., United States Bankruptcy Court, S.D. Georgia, Augusta Division, (February 1, 2019).

Comment. This case demonstrates what a grey area is out there when it comes to landlord or tenant ownership of fixtures. A lesson for a buyer of a business that operates out of a leased facility would be to determine in due diligence if there are any valuable business assets that may be subject to an ownership claim by seller’s landlord.

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

Email: jmccauley@mk-law.com

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

Telephone:      714 273-6291

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.

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