Seller Argues That Indemnification Cap Applies to Excluded Liabilities

Introduction

An advantage of an asset sale is that a buyer can pick and choose which seller liabilities the buyer wants to be responsible for under the asset purchase agreement; often referred to as the assumed liabilities.

However, the buyer may have to deal with unassumed seller liabilities (often referred to as excluded liabilities or retained liabilities). There are several reasons for this. In some cases, the excluded seller liability is owed to a valuable customer that the buyer wants to keep happy. Or the buyer may get stuck with a seller liability under federal or state law even if the buyer did not assume the seller liability in the asset purchase agreement; this type of liability inventory was “usable and salable in the ordinary course of business (often called successor liability).

In either case, the buyer often requires the seller to promise in the asset purchase agreement to indemnify the buyer for paying off these seller liabilities.

The deal

Our seller was an Akron based private equity firm specializing in investments in distressed or underperforming middle market and mature companies. Through subsidiaries, it owned and operated a chemical division that chiefly sold research and development services to biotech, pharmaceutical, food, flavor, fragrance and specialty chemical customers.

The seller sold the chemical division to the buyer for $27 million; and an opportunity for an earnout of $5.5 million if the business hit an earnings target for the first year after the closing.

The lawsuit

The buyer had a post-sale contract dispute with a seller customer arising from allegedly contaminated chemical inventory the buyer acquired from the seller. Buyer subsequently agreed to settle this dispute for $2.25 million.

The seller refused to indemnify the buyer for the $2.25 million loss. They wound up in an Ohio federal district court.

The seller argued that the buyer’s indemnification claims had already exceeded the asset purchase agreement’s indemnification cap of 10% of the purchase price. The seller said that the buyer was accusing it of breaching seller’s asset purchase agreement representation and warranty that the seller inventory was “usable and salable in the ordinary course of business.” The seller pointed out that the indemnification cap applied to all its breaches of representations and warranties and that buyer’s representation and warranties indemnification claims had already exceeded the cap.

The buyer pushed back saying that the seller was responsible for the buyer’s $2.25 loss even if the buyer’s loss arose from a seller representation and warranty breach. That is because the indemnification cap did not apply to the seller’s asset purchase agreement promise to indemnify the buyer for any loss the buyer suffered from the seller’s excluded or retained liabilities; or a buyer loss arising out of the operation of the chemical division by the seller before the closing.

The court held that the indemnification cap provision could be read either way and so the dispute must go to trial and not be disposed of in this preliminary proceeding.

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]

Comment

Frankly, the buyer seems to have the much better argument. I suspect that it will be decided by the court or jury that the intent was to limit the indemnification cap to a breach of reps and warranties only. That means that the cap does not apply to a seller breach of any of its other seller promises made in the asset purchase agreement.

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

Email: jmccauley@mk-law.com

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

Telephone:      714 273-6291

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Posted in asset purchase agreement, excluded or retained liabilites, indemnification cap, post closing covenants Tagged with: , , , ,

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