Explore a real-world case study of the legal complexities surrounding oral side deals in mergers and acquisitions (M&A). Learn about the risks, challenges, and key legal points from a business seller’s perspective.
August 12, 2020
Introduction:
In mergers and acquisitions, parties sometimes agree to certain terms orally to avoid tax issues. These side agreements, made through handshakes, carry risks. This blog discusses a case where a business seller faced legal challenges due to such an oral side deal.
The Story:
In this case, a business owner in Hawaii sold his business’s assets for $23 million to a private equity buyer in 2007. The buyer’s lenders were concerned about the seller’s ongoing involvement, leading to a revised deal. The seller’s manufacturing company would receive buyer stock alongside cash, with a predetermined cash-out in 3 years. However, a mandatory stock buyback caused tax problems for the manufacturing company. To solve this, they removed the buyback obligation from written documents and relied on an oral agreement.
Legal Battle:
After the acquisition, the business struggled due to the recession and mismanagement. In 2010, the buyer couldn’t afford the stock buyback. The seller sued and won in a California court, but the buyer appealed. The Court of Appeals upheld the judgment.
Key Legal Points:
The buyer argued against the oral agreement using the “parol evidence rule” and an integration clause. The Court ruled that the integration clause didn’t block additional terms consistent with written documents. The oral agreement was seen as complementary to the written deal.
This case is referred to as Kanno v. Marwit Capital Partners II, LP, No. G052348, Court of Appeals of California, Fourth District, Division Three, (December 22, 2017).
Important Consideration:
Had the IRS known about the side deal, they might have taxed the gain in 2007. There’s a risk of the IRS pursuing tax fraud, even now, as there’s no time limit for tax fraud cases. Thus, the potential risks of oral agreements include legal expenses, enforcing the agreement, and the possibility of tax penalties from the 2007 tax year.
By John McCauley: I help manage the tax risks associated with buying or selling a business.
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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