Explore a case study from March 10, 2020, involving a medical device company acquisition and the implications of not pursuing fraud/breach claims post-closing. Learn about the court’s ruling and the importance of timely action in M&A deals.
March 10, 2020
Introduction
It is not uncommon for a business buyer to find undisclosed problems in the acquired business after the closing; problems that the seller’s owner most certainly knew about. Nevertheless, the buyer often makes a business decision to forego a fraud/breach claims against the seller’s owner; especially if the seller’s owner has been hired to grow the business.
That might have regrettable consequences for the buyer if the deal can’t be salvaged.
The deal
This case involved the 2011 acquisition of a medical device company by a publicly traded company. The buyer acquired the target company in a merger for $10 million in cash and $22.5 million in buyer stock. Furthermore, the sellers could receive earnout payments in buyer stock upon the achievement of future milestones.
The lawsuit
The buyer learned after the closing (in 2012) that the target products had many undisclosed problems. Buyer, however, decided not to sue the owners (who stayed after the closing); fix the defects; and get FDA approval of the product.
The product fixes took some time. Buyer secured FDA approval in 2019; the first merger agreement milestone triggered a buyer payment to the owners of $2.375 million in buyer stock.
The buyer refused to pay the earnout, and the dispute ended up in the Delaware Court of Chancery. Buyer conceded that it was too late under Delaware’s statute of limitations to bring a claim against the owners for fraud or breach of the merger agreement’s representations and warranties. Instead, the buyer sought to recoup or offset its damages the buyer suffered as a result of the owners lying about the problems with the medical devices against the earnout payment.
The owners argued that the buyer could not recoup its stale claims against the earnout, and the court agreed; finding that the alleged owner fraud and contract breach had little to do with whether the owners were entitled to the earnout. The court said it made “little sense as a matter of policy” to permit the buyer “to sit on its contractual rights and wait until” the FDA has approved the medical device. By that time, much of the evidence pertinent to the fraud and contract breach claims, such as testimony “might be unavailable or less reliable, and … (the owners) … might be unable to mount a successful defense.”
This case is referred to as Claros Diagnostics, Inc. v. OPKO Health, Inc., C.A. No. 2019-0262-SG, Court of Chancery of Delaware (Decided: February 19, 2020).
Comment
Not pursuing a post-closing claim may have its advantages, but in the calculation always remember that the expiration of a statute of limitation has real consequences. In most circumstances, the defrauded buyer will not be able to offset damages buyer suffered from an expired claim against post-closing seller payments.
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 Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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