Discover why winning a technical legal argument in M&A can still result in costly litigation. This analysis of the Novolex case explains why lower middle market sellers must disclose material customer losses—specifically regarding purchase orders versus binding contracts—to avoid post-closing disputes, fraud claims, and Representation and Warranty Insurance denials.
M&A Stories
December 4, 2025
A seller might legally prove they didn’t breach a specific contract representation, but silence regarding a major customer’s departure can still lead to years of expensive litigation.
The Scenario
Imagine you are selling your manufacturing or distribution business. As is standard, your purchase agreement contains a “Material Relationships” representation. This clause requires you to disclose if any top customer has given you written notice of their intent to terminate, cancel, or materially modify their contract with you.
One of your largest customers, a big-box retailer, suddenly stops ordering from you. You do not have a guaranteed volume contract with them; instead, you operate under a Master Vendor Agreement, and they issue individual purchase orders when they need stock. Following a dispute over pricing and service, they simply stop issuing new purchase orders. They do not send a formal letter canceling the Master Vendor Agreement. They just ghost you.
Do you disclose this to the buyer?
The Novolex Case
In a recent case, Novolex Holdings, LLC v. Illinois Union Ins. Co., a seller faced this exact dilemma involving Costco. The seller decided not to disclose the significant drop in business volume on the disclosure schedules. Their reasoning was based on a strict legal interpretation of the deal documents: because Costco had not formally terminated the Master Vendor Agreement, but had merely stopped sending new purchase orders, there was no “modification of a Contract” to disclose.
After the deal closed and the buyer discovered the loss, the buyer filed a claim against their Representation and Warranty Insurance (RWI) policy. The buyer’s RWI carrier denied the claim, effectively using the seller’s own logic against the buyer. The insurer argued that because the framework agreement did not guarantee future volume, the customer’s decision to stop issuing purchase orders was not technically a breach of the seller’s “Material Relationships” representation.
The New York court agreed with the insurer. The judge ruled that the drop in purchase orders was not technically a breach of the specific “Material Relationships” clause because no binding contract had been modified.
The High Cost of Technical Victories
However, that technical victory regarding the insurance policy did not end the dispute for the seller. Because the buyer felt blindsided by the loss of such a significant customer and could not recover from their insurance, they launched a multi-front legal battle. While the insurer was fighting in New York, the buyer sued the seller directly in a Delaware state court for fraud and breach of contract and sued the target’s former CEO in federal court.
The seller may have been technically correct that a drop in purchase orders is not a “contract modification,” but their silence regarding the business reality trapped them in expensive, high-stakes litigation years after the deal closed. The New York court also denied summary judgment on other claims regarding “Material Adverse Effects,” ensuring the dispute would drag on.
The Fix: Voluntary Disclosure
For lower middle market owners, the goal is to avoid a lawsuit entirely, not just to provide a defense for a legal argument years later. The lesson from this case is that relying on technical definitions to hide bad news is a dangerous strategy.
The solution is to prioritize transparency over technicalities by utilizing the disclosure schedules. Even if your lawyer advises you that a drop in purchase orders does not strictly meet the definition of a “contract modification,” you should disclose the issue in a written communication and on the disclosure schedules.
A protective disclosure might state that a specific customer has indicated an intent to reduce order volume or has paused the issuance of new purchase orders pending pricing discussions. It should further note that projected revenue from this customer for the remainder of the year is uncertain.
Conclusion
Making this disclosure is painful. It will almost certainly cause the buyer to pause, and they may demand a reduction in the purchase price or an earnout structure to protect themselves. However, accepting a negotiated reduction in price at the closing table is far superior to funding a multi-year legal defense. If you rely on a technicality to withhold critical information about your customers, you might win the legal argument, but you will likely lose the war.
See: Novolex Holdings, LLC v. Illinois Union Ins. Co., Index No. 655514/2019, Motion Seq. Nos. 014, 015, Supreme Court, New York County (January 12, 2024).
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 in lower middle market private target deals.
By John McCauley: I write about recent problems of buyers and sellers in lower middle market private target deals.
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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