Navigate the complexities of M&A law with insights into recent cases impacting buyers and sellers in the lower middle market. This post analyzes the PDS Acquisition v. KDHM ruling, revealing a crucial pitfall for sellers regarding the treatment of earned customer deposits in asset sales and offering actionable advice to minimize litigation risks through diligent due diligence, precise contractual language in the Asset Purchase Agreement, and proactive negotiation. Understand how seemingly standard “excluded assets” clauses can lead to unexpected financial consequences and learn how to protect your interests in lower middle market M&A deals.
M&A Stories
April 6, 2025
In lower middle market asset sales, sellers often retain cash as an “excluded asset.” However, the treatment of customer deposits – advance payments for future goods or services – can be a surprising source of M&A disputes. A recent Texas case, PDS Acquisition, Corp. v. KDHM, LLC, highlights a critical pitfall for sellers regarding these deposits.
The 2020 sale of a printing business hinged on the definition of excluded customer deposits, which were defined as those “not been earned and offset against seller’s accounts receivable prior to closing.” Despite the seller, KDHM, having already earned some deposits by completing the work, the failure to “offset” them in their accounting before closing led to a post-closing battle with the buyer. The buyer successfully argued that these deposits were not excluded assets.
The appellate court sided with the buyer, interpreting the agreement to require both that deposits were unearned and un-offset to be excluded. Because the deposits were earned, they were deemed part of the acquired assets, even though the seller had performed the work. This outcome underscores a crucial lesson for sellers: the specific wording of the Asset Purchase Agreement (APA) regarding excluded assets, particularly customer deposits, carries significant weight.
Economically, the seller likely believed they should retain cash for work already completed. However, the APA’s requirement for the “offset” accounting step to be finished before closing proved decisive. This case serves as a clear warning to sellers and their advisors in the lower middle market to proactively address the treatment of customer deposits with precision in the APA.
To minimize the risk of such disputes, sellers should advocate for straightforward language defining excluded customer deposits based on whether the related work and revenue recognition occurred before closing, without adding conditions tied to the completion of specific accounting procedures like the “offset.” Clear drafting, thorough pre-closing due diligence on both sides regarding deposit accounting, and open negotiation about which deposits will be retained are essential steps to avoid unintended transfers of value and potential post-closing litigation.
See: PDS Acquisition, Corp. v. KDHM, LLC No. 04-24-00358-CV, Court of Appeals of Texas, Fourth District, San Antonio, (April 2, 2025).
Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.
Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law.
By John McCauley: I write about recenegal problems of buyers and sellers of small businesses.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my books: Buying Established Business Assets: A Guide for Owners, https://www.amazon.com/dp/B09TJQ5CL5
and Advisors and Selling Established Business Assets: A Guide for Owners and Advisors, https://www.amazon.com/dp/B0BPTLZNRM
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