The buyer of a company wants to minimize the risk that it overpays for a company. One way to minimize this risk is thorough due diligence. Find out everything you can about the target business.
In addition, the buyer will want the seller to make comprehensive representations and warranties about the target business in the purchase agreement.
Purchase agreement representations and warranties can go on for page after page. And they are important. The seller is making representations and warranties about the business that the seller says are true. And if a representations and warranty is not true, the seller may be liable to the buyer for any loss the buyer suffers as a result of the misrepresentation.
Some seller representations and warranties are absolute. Such as a representation and warranty that the seller owns the business and has the authority to sell the business to the buyer.
Other statements are conditional. Such as the company’s balance sheet given to the buyer discloses all liabilities of the business except for those liabilities described by the seller on what is called a disclosure schedule. A disclosure schedule is prepared by the seller, reviewed by the buyer, and becomes part of seller’s purchase agreement representations and warranties.
This deal involved a company that provided health care coverage to members under the Medicaid and Child Health Plus programs in three upstate New York counties. Under the terms of a stock purchase agreement, the buyer agreed to buy all the company’s outstanding stock from the seller for $41.3 million.
The stock purchase agreement was signed on April 19, 2016. In it, the seller represented that there were no undisclosed liabilities of the company other than those disclosed on a disclosure schedule delivered by the company to the buyer before the signing.
About 10 months later, the company got a demand from the New York Department of Health for the company to return $1.4 million of income it has received from the New York Department of Health during the 12 month period that ended in April 2016. In other words, New York wanted the company to return preclosing income.
The buyer wanted the seller to pay this liability because the seller had not disclosed it and the seller refused. The buyer then sued the seller in a New York state court and lost.
The buyer argued that the seller breached its stock purchase agreement representation and warranty by not disclosing this $1.4 million liability. But the court said that no one knew of the liability at the time of the signing of the stock purchase agreement or when the deal closed. Nevertheless, the seller had disclosed the possibility of this kind of liability in its disclosure schedule when it said that said that based on New York Department of Health reconciliations, the company may need to pay back a portion of payments it received and the exact amount that may be owed is currently unknown.
This was enough seller disclosure for the court because the New York Department of Health liability was clearly disclosed as a potential future liability on the disclosure schedule.
Buyer’s claim was dismissed.
This case is referred to Molina Healthcare, Inc. v. Wellcare Health Plans, Inc., Docket No. 651328/2018, Motion Seq. No. 001, Supreme Court, New York County, (April 8, 2019) https://scholar.google.com/scholar_case?case=3450975109110859669&q=%22stock+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017
Preparation of disclosure schedules are very important for the seller. Disclosing any potential problem about the business in the disclosure schedule minimizes the risk that the seller will have to pay back to the buyer all or a portion of the purchase price.
Nevertheless, the value to the seller of disclosure schedules is often overlooked. Especially because preparation takes a lot of time. And at first blush, are boring. Also, the seller waits until right before they are needed, and in the rush of time are not complete.
On the flip side, the buyer is scrambling to close the deal and often overlooks reviewing the disclosure schedules in order to assess if there are any problems disclosed that need to be addressed before the deal closes.
The lesson for both buyer and seller is not to neglect disclosure schedules.
By John McCauley: I help businesses minimize risk when buying or selling a company.
Telephone: 714 273-6291
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