Buyer Can’t Stop Noncompete Payments Upon Death of the Seller of the Business

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Buyer failed to convince the Alabama Supreme Court that the noncompete was a personal service contract terminable upon the death of the seller owner.

M&A Stories

May 12, 2021

Introduction

A covenant not to compete is generally given by the owner of the sold business to protect the value of the goodwill of the business purchased by the buyer. And often significant noncompete payments are paid after the closing over a period of years.

The deal

This deal involved the stock sale by the founder of the target which was a wholesale distributor of construction and highway-industry products. The buyer was the target’s president. The seller/founder gave a noncompete to the buyer in exchange for over $2 million, payable in 120 post closing monthly payments.

The lawsuit

The seller died 7 years after the closing and the buyer stopped making the monthly noncompete payments. The seller’s estate sued for the remaining payments of $641K, and the dispute ended up in the Alabama Supreme Court.

The buyer argued that the noncompete was a personal service contract which was terminable upon the seller’s death. The Alabama high court disagreed. It held that the essential benefit of the noncompete was a purchase of the business’s goodwill (as opposed to the seller’s expertise), so the seller’s death did not deprive the buyer of this benefit. “Thus, the noncompete was not a personal-service contract in which ‘personal performance by the promisor is of the essence.’ ... And because it is not a personal-service contract, the noncompete ‘survives the death of the decedent’ and the … (the seller’s estate) … has the right to enforce the noncompete.”

This case is referred to as Boyd v. Mills, No. 1190615, Supreme Court of Alabama, (April 23, 2021). 

Comment

There was a dispute because the noncompete did not specify whether the payments stopped upon the seller’s death. That could have been fixed either way by saying so in the noncompete.

By John McCauley: I help people manage M&A legal risks.

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.

Posted in covenant not to compete, death of seller's impact upon noncompetition payments Tagged with: ,

Delaware Court Says that Acquisition Agreement Jury Waiver Not Applicable to TSA

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Delaware “courts construe jury trial waivers narrowly and indulge every reasonable presumption against the waiver …”

M&A Stories

May 11, 2021

Introduction

It is quite common for a business buyer and seller to expressly waive their right to a jury trial in a dispute over the acquisition. However, there may be a fight over a jury waiver when a dispute breaks out over related transactional documents.

The deal

This deal involved a strategic acquisition in the packaging industry. The buyer purchased a wholly owned limited liability company subsidiary of the seller. The buyer and seller expressly waived “all right to trial by jury in any litigation … arising out of … this Agreement …”

Under the purchase agreement the parties agreed to execute a transition services agreement (“TSA”), substantially in the form attached as a schedule to the purchase agreement. The parties executed the TSA about a month after the closing.

The lawsuit

The buyer and the target sued the seller about 2 years after the closing in a Delaware Superior Court “alleging … (the seller) … breached the TSA by failing to pay for certain goods …  manufactured for … (the seller).  The buyer asked for a jury trial and the seller resisted arguing that the buyer had expressly waived its right to a jury trial under the purchase agreement.

The Delaware trial court disagreed. It first noted that Delaware “courts construe jury trial waivers narrowly and indulge every reasonable presumption against the waiver …”

The court looked at the jury waiver in the purchase agreement and noted that it did not apply to the TSA, only the purchase agreement: “Purchase Agreement Section 9.12 waives the right to a jury trial for claims arising out of and relating to “this Agreement.” … ‘Agreement’ expressly is defined on page one of the Purchase Agreement as “this MEMBERSHIP INTEREST PURCHASE AGREEMENT.” This definition of “Agreement” does not include the TSA.”

Thus, the buyer is entitled to a jury trial.

This case is referred to as Tekni-Plex, Inc. v. LLFlex, LLC, No. C.A. No. N20C-09-062 AML CCLD, Superior Court of Delaware, (Submitted: March 18, 2021. Decided: April 22, 2021). 

Comment

It is common in acquisition deals to select Delaware as the applicable law and forum. One takeaway then when dealing with Delaware law is to remember that Delaware does not favor jury waiver provisions.

However, the jury waiver provision in this deal would have applied to the TSA if the jury waiver provision expressly applied not only to “this Agreement” but also to “Contemplated Transactions” which was defined in the purchase agreement to include the TSA.

By John McCauley: I help people manage M&A legal risks.

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.

Posted in waiver of jury trial Tagged with: ,

Indiana High Court Requires Continuity of Ownership in Successor Liability Claim

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Business asset buyer not liable to seller creditor under Indiana’s de facto merger or mere continuation successor liability exceptions to the successor liability doctrine.

M&A Stories

April 30, 2021

Introduction

Successor liability is an important issue when pricing a business asset acquisition. Generally, a buyer is only responsible for seller liabilities assumed in the asset purchase agreement. However, there are some federal and state successor liability risks.

The deal

The South Bend, Indiana seller in this case manufactured utility and cellular towers. The buyer was a bank that the seller owed $10 million to under a bank loan that was secured by a first lien on the … (the seller’s) … assets. The … (the seller’s) … owners had personally guaranteed the loan.

The seller was in financial difficulty. The liquidation value of the … (the seller’s) … assets was about $3.1 million.

In November 2017, the seller agreed to the buyer acquiring the … (the seller’s) … assets by foreclosure. “Afterward, … (the buyer) … continued operating from … (the seller’s) … former location without publicly announcing either the transition or the transfer of assets from … (the seller) …. (The buyer) … retained about ninety percent of … (the seller’s) … employees, including senior management. Although senior management had owned the lion’s share (at least ninety-five percent) of … (the seller’s) … shares, none of … (the seller’s) … shareholders owned any equity interest in … (the buyer) … As part of the transition, … (the buyer) … agreed not to enforce the personal guarantees against … (the seller’s) … four senior officers, all of whom agreed to remain in their positions at … (the buyer).”

The lawsuit

A creditor had installed piping in the seller’s South Bend facility in early 2016 but had not been fully paid for its work. It made a claim against the buyer in an Indiana trial court. Both the trial court and the intermediate appellate court held the buyer liable to the creditor under Indiana successor liability doctrine, even though none of the seller owners had an ownership interest in the buyer.

The Indiana Supreme Court, in a unanimous decision reversed: “In a typical asset purchase, the buyer acquires the seller’s assets but not its liabilities. The general rule is not absolute, however, and this case turns on two exceptions. The first exception arises when the acquisition of assets amounts to a de facto merger; the second, when the buyer is a mere continuation of the seller. If either exception applies, the buyer is on the hook for all the seller’s liabilities … (W)e hold that continuity of ownership is necessary for the de-facto-merger and mere-continuation exceptions to apply. Because there was no continuity of ownership between … (the seller) … and … (the buyer) …, we reverse the trial court’s entry of judgment for … (the creditor) … and remand with instructions to enter judgment for … (the buyer) …”

This case is referred to as New Nello Operating Co., LLC v. CompressAIR, Supreme Court Case No. 20S-CC-578, Supreme Court of Indiana, (Argued: December 3, 2020. Decided: April 22, 2021). 

Comment

Generally, successor liability requires that the seller owner has an ownership stake in the buyer. But some states don’t always require continuity of ownership.

By John McCauley: I help people manage M&A legal risks.

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.

Posted in continuity of enterprise exception, continuity of ownership, de facto merger exception, successor liability Tagged with: ,

Court Says Buyer Prepared LOI That Seller Signed Is Probably Unenforceable

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Although the seller signed the buyer prepared LOI, it included additional terms which were never agreed to by the buyer.

M&A Stories

April 30, 2021

Introduction

A letter of intent (or LOI) is often used in a private deal to summarize the key business terms of a proposed transaction. This summary is contained in a nonbinding section of the document. There are usually some binding terms. A common binding term prohibits the buyer from soliciting the seller’s employees.

The deal

This case involved a failed deal between competitors in the mortgage lending industry. The buyer and seller key executives negotiated the major business terms of a proposed acquisition in 2019. The buyer’s president left the details to be worked out by the buyer’s COO/chief legal officer.

The buyer sent a draft LOI to the seller. The seller signed it but included a “lengthy addendum” which would prohibit the buyer from soliciting or hiring any seller employees for 2 years. The buyer was willing to include a nonsolicitation restriction but not a prohibition of hiring seller’s employees where the buyer did not solicit the seller employee.

The lawsuit

The deal never happened. Later the seller and buyer ended up a Minnesota federal district court with a claim by seller that the buyer solicited and hired its employees in violation of a letter of intent. The seller wanted the court to restrain the buyer from soliciting and hiring its employees while the seller and buyer battled in court.  The court refused because the buyer probably never agreed to refrain from soliciting or hiring seller employees.

The court noted that the seller’s signed LOI was not binding upon the buyer because the seller had added additional terms. The seller’s “proposed revisions effectively created a third draft of the letter of intent.” That third draft LOI was a seller offer that would only be binding on the buyer when and if the buyer accepted the revisions by signing the LOI as revised by the seller. The buyer never did that.

This case is referred to as American Mortgage & Equity Consultants, Inc. v. Everett Financial, Inc., No. 20-cv-426 (ECT/KMM), United States District Court, D. Minnesota, (February 28, 2020). 

Comment

The takeaway. Assume that a LOI is not binding (to the extent of the binding provisions in the LOI) until both the buyer and the seller have signed an LOI that contains the same terms and conditions.

By John McCauley: I help people manage M&A legal risks.

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.

Posted in letter of intent, signing LOI with revisions by signer Tagged with: ,

Asset Buyer Fights Claim That It Assumed Liability for Product Line Containing Asbestos

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Buyer only purchased certain product lines of seller but also purchased the trade name that seller used for all product lines including a steam turbine product line that contained asbestos which the seller did not sell to the buyer.

M&A Stories

April 20, 2021

Introduction

One major advantage of an asset purchase over a stock acquisition is that the buyer can generally pick and choose what liabilities the buyer wishes to assume. However, a seller creditor may still sue the buyer when the financial claim is significant.

The deal

The buyer in this deal purchased 2 product lines from the seller in 1987. The purchased product lines were “the Commercial and Industrial heating and Make-Up Air business”. The buyer expressly assumed seller’s liabilities for the purchased product lines.

The buyer also purchased the trade name that the seller used in its business operations. This trade name had also been used by the seller before the closing, for the product lines retained by the seller. Those lines were the “Heat Recovery Wheel business and a… Draft Inducer business …”  After the closing, the seller could not use the trade name for those product lines because the trade name had been sold to the buyer

The lawsuit

In 2019, a claimant filed a petition for damages against a customer of the seller. He alleged that the seller sold a steam turbine to this customer, a company that manufactured ships for the military, which contained asbestos. The claimant alleged that he was recently diagnosed with malignant mesothelioma, and that his mesothelioma was caused by exposure to asbestos from several sources, including asbestos allegedly brought home on the work clothes of his father, who worked at the ship manufacturer from 1943 to 1945.

The seller’s customer sued the buyer arguing that the buyer had assumed this liability because it had expressly assumed in the asset purchase agreement the liabilities associated with the business, purchased from the seller, and the business included the seller trade name.

The buyer filed a motion for summary judgment asking the court to dismiss the ship manufacturer’s claim against it, saying that it did not purchase the steam turbine product line and in fact never manufactured steam turbines.

The court denied the buyer’s motion for summary judgment: “This Court agrees that … (the buyer) … has not established that it is entitled to summary judgment as a matter of law on the issue of whether it acquired the assets and liabilities associated with the steam turbines and turbine-driven blowers. Genuine issues of material fact exist as to what assets and liabilities … (the buyer) … intended to acquire from … (the seller) … and what assets and liabilities it legally assumed.

This case is referred to as Egendre v. Lamorak Insurance Company, Civil Action No. 19-14336, United States District Court, E.D. Louisiana, (March 31, 2021). 

Comment

Liability for asbestos products sold decades before a closing can still be a problem for business asset buyers.

In this case it would seem a stretch to say that the buyer assumed the liabilities for the offending steam turbine line simply because it purchased the seller’s trade name; especially if there is convincing evidence that the steam turbine products were part of seller’s retained assets.

By John McCauley: I help people manage M&A legal risks.

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.

Posted in buyer assumption of seller liability, successor liability Tagged with: ,

Seller Has Post-Closing Problem with His Pre-Closing Guaranty of Target Lease

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Target falters after closing and stops paying rent to its landlord. The seller sues the target and the buyers to manage his exposure because of personal guaranty he gave to landlord.  

M&A Stories   

April 14, 2021  

Introduction  

It is very common for the owner of a company to guaranty the company’s office or facility leaseThis personal guaranty is a source of risk for the owner when selling the company. The deal below illustrates the problem  

The deal  

The seller in this deal previously founded the target which executed a commercial office lease with the landlord. As a condition of the lease agreement, the seller also executed a guaranty, under which he personally promised to pay rent due under the lease agreement in the event the target failed to perform its obligations under the lease. Two years laterthe seller sold a majority interest in the target to the buyers pursuant to the terms and conditions of a stock purchase company  

The target began experiencing financial difficulty and its last rent payment under the lease agreement was about a year after the closingFive months later the landlord commenced an action against target and the seller alleging breach of contract against the target for breach of the lease agreement and against the seller for breach of the guaranty agreement.   

The lawsuit  

The seller sued the target and the buyers in a New York state court. Notably there was no claim that the buyer or target breached any promise in the stock purchase agreement to indemnify the seller for a target breach of the lease.   . 

This case is referred to as 950 Third Ave. LLC v. Theirapp, Inc., Docket No. 653316/2020, Third-Party Index No. 595747/2020, Motion Seq. No. 001., Supreme Court, New York County(April 1, 2021). https://scholar.google.com/scholar_case?case=9776270755032175666&q=%22stock+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2020  

Comment  

The seller does not appear to be in a strong legal position from what we know of the facts.    

So, how can a seller deal with a personal guaranty of his company’s lease when selling his company?  

The best M&A legal risk management tool would be for the seller to get the landlord to release the seller from his or her personal guaranty before the closingFailing that, the seller could require the target and buyer to indemnify the seller for any loss the seller suffers under the guaranty. This risk management tool would be significantly enhanced by some sort of meaningful security for the indemnification, such as a letter of credit or an adequately funded escrow arrangement.  

By John McCauley: I help people manage M&A legal risks.  

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.

Posted in shareholder personal guaranty of target lease, stock purchase agreement Tagged with: ,

Buyer Accuses Timeshare Business Seller of Signing Credit Risk Members Before Closing

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Delaware Court denies seller’s motion to dismiss buyer’s claims that seller changed practice before closing by signing up customers with low FICO scores.  

M&A Stories   

April 13, 2021  

Introduction  

A buyer uses past performance and future projections to help price a target business. The purchase agreement usually contains representations and warranties that the seller has not changed practice since the last available financial statements. This deal illustrates why those representations and warranties help manage that risk. 

The deal  

This deal involved the acquisition of timeshare resort assets. The buyer purchased the timeshare business and existing contracts with the timeshare members and the seller retained the majority right to the payment stream on those existing contracts. The buyer was responsible for collecting from the timeshare members.  

The seller represented and warranted in the purchase agreement that since the lasted audited financial statements it had not changed, in any material respect, any credit policies or policies or practices relating to the collection of the Timeshare Installment Contracts and Accounts Receivable or payment of payables; … (or changed) … in any material respect, the underwriting standards or other credit criteria for the sale and/or financing of the sale of Timeshare Interests …”  

The lawsuit  

After the closing the buyer sued the seller in Delaware state court. One of its claims was that the buyer discovered after the closing that the seller had in fact changed its underwriting practice after the date of the last audited financial statements by lowering its underwriting standards for new members by signing up members with much lower FICO scores than it had in the past. The buyer claimed that seller fraudulently induced the buyer to sign the purchase agreement by not telling the buyer of the changed underwriting practice.  

The seller’s motion to dismiss this claim was denied and the litigation will continue.  . 

This case is referred to as CRE NIAGARA HOLDINGS, LLC v. RESORTS GROUP, INC., C.A. No. N20C-05-157 PRW CCLD , Superior Court of Delaware(Submitted: February 19, 2021. Decided: April 7, 2021.).  

Comment  

The buyer also sued the seller for breach of the above representations and warranties. However, the breach of representations and warranties claim is subject to an agreed upon indemnification cap. Damages for fraudulent inducement should be free of the indemnification cap.  

By John McCauley: I help people manage M&A legal risks.  

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.

Posted in exclusive remedy, fraud carveout, fraud in business sale, fraudulent inducement Tagged with: ,

Asset Buyer Can’t Enforce Employee Nonsolicitation Covenants

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Oklahoma federal court refuses to enforce several employee non-solicitation post-employment covenants because they were either non-assignable, had no term, applied to indirect solicitation or were not restricted to established customers.

M&A Stories

April 11, 2021

Introduction

One buyer M&A risk is for seller’s employees to walk out the door after the closing taking seller customers. One tool to manage this risk is get the employees to sign an agreement promising to not solicit the seller’s customers after employment termination. However, the enforcement of a non-solicitation provision depends upon applicable state law, which varies from state to state.

The deal

The buyer in this deal is a national lawncare company that provides residential and commercial customers across the United States with lawn, tree and shrub care, among other services. The target was an Oklahoma based competitor.

The target agreed to sell its assets to the buyer pursuant to an asset purchase agreement. The transaction closed October 9. 2019.

Prior to entering into the APA, Seller had its employees sign non-solicitation agreements. Some seller employees signed an agreement prohibiting the employee from directly soliciting seller’s established customers for two years after employment termination. The other form of agreement prohibited an employee from directly or indirectly soliciting any customer who the employee had been in contact with. These agreements were part of the assets acquired by the buyer.

The buyer also had all seller employees it hired sign agreement which prohibited the employee from directly or indirectly soliciting a buyer customer which the employee had actual contact for 1 year after employment termination.

After the closing several seller employees who were hired by buyer, left and competed against the buyer. Some of these employees signed one version of the seller nonsolicitation agreement and others signed the other seller nonsolicitation agreement. They all signed the buyer nonsolicitation agreement.

The lawsuit

The buyer sued these former employees in federal district court claiming that they violated a seller nonsolicitation agreement and the buyer nonsolicitation agreement.

The former employees asked the court to dismiss the nonsolicitation claims and the court granted their request.

The court noted that a nonsolicitation provision is only enforceable in Oklahoma for the prohibition of “direct” solicitation of “established” customers. The buyer’s provision failed because it prohibited “indirect” solicitation which would include for example advertising or meeting a former customer at a trade show.

The one seller nonsolicitation agreement failed because it had no term; the other because the seller could not assign it to the buyer without the employee consent.

This case is referred to as TruGreen Limited Partnership v. Oklahoma Landscape, Inc., Case No. 20-CV-71-TCK-CDL, United States District Court, N.D. Oklahoma, (March 17, 2021). 

Comment

Be careful to comply with local law if you want to restrict seller customers competing against you.

The buyer also had a noncompete provision which under Oklahoma law is only permissible when the noncompete is given by someone selling a business.

By John McCauley: I help people manage M&A legal risks.

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.

Posted in nonsolicitation of employees and customers, nonsolicitation of former customers Tagged with: ,

DOL sues Target Directors for Breach of Fiduciary Duties in ESOP Transaction

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DOL claims that independent ESOP trustee overpaid for the majority owner’s stock and sued the company’s directors for breach of fiduciary duty.  The purchase price was 2.5 times higher than the prior 5 years ESOP valuations.

M&A Stories

March 29, 2021

Introduction

One exit strategy for a retiring business owner is to sell his or her company to an ESOP. However, there are ERISA risks for transaction participants if the ESOP overpays for the owner’s stock.

As a result, it is common for the target’s board of directors to appoint an independent ESOP trustee to purchase the owner’s stock for the ESOP. Nevertheless, target directors may have ERISA liability if the independent ESOP trustee overpays for the stock.

The deal

The target in this deal was a Minneapolis based manufacturer. The son of the founder was the board chairman and owned 76% of the company and in 2010 was about 80 years old. The ESOP owned the rest.

The ESOP stock valuation for the five years before the closing fluctuated from $14 to $34 per share. The target had a 5-member board which included the president, VP of Finance and VP of Human Resource. All directors served as ESOP trustees.

The board began looking at an ESOP transaction in the spring of 2011. The seller brought a financial advisory firm to the board for consideration of a sale of his stock to the ESOP in March or April of 2011 that had experience in ESOP transactions.

On April 28, 2011, the firm made a presentation to the board. In its presentation, the firm estimated that the seller’s stock was worth $28.7 million, or about $63 per share. The firm’s presentation noted that the benefits of an ESOP transaction included the key officers’ retention of their positions as officers and directors and supplemental incentive compensation for them.

The advisory financial firm revised its estimate to $74 per share on June 24; $84 per share on June 30; and $85 per share on July 11th.

Management worked on financing for the deal with a bank. On July 18 the bank advised management that its projections on which the financial advisory firm’s valuations were based were “very aggressive when compared to past performance” and observed that the “figures considerably exceed actual performance for each of the last 6 years.”

Four days later, the directors resigned as ESOP trustees and appointed an independent trustee to serve as the ESOP’s trustee, that was recommended by the financial advisory firm. The deal closed October 5, 2011 with the ESOP paying seller $39 million, or $85 per share.

The lawsuit

The Department of Labor or DOL sued the independent trustee and the three officers, in their capacity as directors, for various ERISA violations. The three directors challenged the claims by way of summary judgment.

The DOL claims that the directors’ actions in the transaction amounted to a breach of their duties of loyalty and prudence to the ESOP; accusing the directors of being aware of evidence suggesting that the selling price was unreasonably high.

The DOL’s claims against the directors included allegations that the directors orchestrated an overpriced sale to the ESOP and failed to monitor the independent trustee’s behavior in the transaction.

The court reviewed the DOL’s detailed allegations and concluded that director liability could not be settled by summary judgment.

This case is referred to as Scalia v. Reliance Trust Company, No. 17-cv-4540 (SRN/ECW), United States District Court, D. Minnesota, (March 2, 2021). 

Comment

The takeaway here is that an independent ESOP trustee may not insulate management from ERISA liability for an unreasonably overpriced deal. The red lights should have gone off in management’s heads when management provided unreasonably high projections for the transaction and when the 2011 purchase price of $85 per share was 2.5 times higher than any of the 2006 through 2010 ESOP valuations.

By John McCauley: I help people manage M&A legal risks.

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.

Posted in director liability, independent trustee, sale of business to ESOP

Court Permits Mere Continuation Successor Liability Claim Against Buyer

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Buyer purchased assets of seller for cash including a distributor agreement. Buyer did not assume any liability for seller’s breach of the distributor agreement. The court nevertheless permitted distributor to sue the buyer for breach of the distributor agreement for an alleged pre-closing breach, under a mere continuation successor liability theory, in part because seller’s president held himself out as president of a buyer division.

M&A Stories

March 08, 2021

Introduction

There is a risk that a seller creditor may sue the cash buyer of a seller’s business assets for a liability that the buyer did not assume under the asset purchase agreement under a successor liability theory.

The deal

This deal was a strategic acquisition in the printer equipment manufacturing industry. The buyer purchased the assets of the seller, an Illinois based Delaware corporation, for cash. This included a distributor agreement. However, the buyer did not assume any liabilities for seller’s pre-closing breach of a specific distributor agreement.

The lawsuit

After the closing the distributor sued the buyer and seller for defective printers delivered before the closing and also for printers that the seller failed to deliver before the closing.  The distributor claimed that the buyer was liable to the distributor under the mere continuation successor liability theory.

The buyer argued that it could not be liable because it only acquired the seller assets for cash and did not assume any seller liabilities for seller’s breach of the distributor agreement under the asset purchase agreement. The court, citing Delaware cases said: “The court concludes that the proposed amended complaint plausibly alleges a mere continuation theory of successor liability. ‘Mere continuation requires that that the new company be the same legal entity as the old company.’ … ‘The test is not the continuation of the business operation; rather, it is the continuation of the corporate entity.’ … ‘The `primary elements’ of being the same legal entity . . . include `the common identity of the officers, directors, or stockholders of the predecessor and successor corporations, and the existence of only one corporation at the completion of the transfer.’ … ‘(I)mposition of successor liability is appropriate only where the new entity is so dominated and controlled by the old company that separate existence must be disregarded.’”

The court found these allegations in the distributor’s complaint sufficient for a mere continuation successor liability claim: “Here, it is undisputed that … (seller) … sold virtually all of its assets pursuant to the Asset Agreement … After the Asset Agreement’s execution, … (seller’s) … only assets consisted of bank deposits, accounts receivable, and prepaid expenses. … (The seller’s president) … sent correspondence to … (the distributor) … on … (the seller’s) … letterhead following the Asset Agreement’s execution, and represented that he was the President of … (a buyer division) … In addition, the proposed amended complaint alleges that … (the buyer continued) … to employ all of … (the seller’s) … employees, and with … (the seller’s president) … continuing both to fill the same role as … (the seller’s president) … and to work from … (the seller’s) … building (which … (the seller) … sold in the Asset Agreement).”

This case is referred to as Fujifilm North America Corporation v. M&R Printing Equipment, Inc., Civil No. 20-cv-492-LM, United States District Court, D. New Hampshire, (February 24, 2021). 

Comment

This case is disturbing because the court said: “Mere continuation requires that that the new company be the same legal entity as the old company.”  That was clearly not the case here, as after the closing, the business was operated by a buyer legal entity. The seller Delaware corporation did not operate the business after the closing.

Mere continuation successor liability is weak in this case also because no seller officer, director or owner served as an officer or director of buyer or owned an interest in buyer.  The only arguable fact was that the seller president told the distributor that he was now the president of a buyer division.

In 20/20 hindsight, the buyer should not have permitted the seller president to call himself president of a buyer division. Also, a buyer should not give a seller officer, director or owner a title that includes any of these words: director, chief executive officer, chairman, secretary, treasurer or chief financial officer; even if it only applies to an unincorporated buyer division.

By John McCauley: I help people manage M&A legal risks.

Email:             jmccauley@mk-law.com

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

Telephone:      714 273-6291 

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