Explore the intricacies of indemnification caps in M&A deals. Learn about a real case involving a private equity firm, a $2.25 million dispute, and the importance of clarity in asset purchase agreements.
M&A Stories
May 21, 2019
Introduction:
In the world of mergers and acquisitions (M&A), understanding the nuances of indemnification caps is crucial for entrepreneurs, business owners, CFOs, CEOs, and other professionals. In this case, we explore a dispute that highlights the importance of clarity in asset purchase agreements.
The Basics:
When engaging in an asset sale, the buyer has the advantage of selecting which seller liabilities they assume, known as “assumed liabilities.” The seller liabilities staying with the seller are called “excluded liabilities” or “retained liabilities.”
Buyers require sellers to pay the excluded or retained liabilities as part of the asset purchase agreement, and to indemnify the buyer if the buyer is sued by a retained or excluded liability creditor.
The Deal:
Our story involves a private equity firm specializing in distressed companies that sold its chemical division to another party for $27 million, with a potential $5.5 million earnout based on first-year earnings.
The Lawsuit:
After the sale, a dispute emerged when the buyer faced a $2.25 million loss related to allegedly contaminated chemical inventory acquired from the seller. The buyer sought indemnification from the seller, but the seller refused to cover the loss.
The seller argued that the indemnification claims exceeded the 10% cap of the purchase price. They pointed out that this cap applied to all breaches of representations and warranties, and the buyer’s claims had already surpassed it.
The Counterargument:
The buyer contended that the seller was responsible for the $2.25 million loss, irrespective of whether it stemmed from a representation and warranty breach. They argued that the indemnification cap did not apply to breaches of promises made in the asset purchase agreement regarding excluded or retained liabilities, or to promises related to the operation of the chemical division before the sale.
The Court’s Decision:
Ultimately, the court found that the indemnification cap provision could be interpreted in multiple ways. Therefore, the dispute needed to proceed to trial rather than being resolved in a preliminary proceeding.
Conclusion:
The buyer has the better argument. Nevertheless, this case emphasizes the importance of clarity in asset purchase agreements. For entrepreneurs, investors, and professionals involved in M&A, it serves as a reminder to carefully consider the language used in indemnification clauses and to seek legal counsel to ensure that agreements align with their intentions.
Case Reference:
This case is referred to Main Market Partners, LLC v. Olon Ricerca Bioscience LLC, Case No. 1:18-CV-916, United States District Court, N.D. Ohio, (April 9, 2019) https://scholar.google.com/scholar_case?case=4976259500205573361&q=%22asset+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017#r[17]
By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million).
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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