Explore a case where a buyer halted payments in an M&A deal due to alleged financial inaccuracies, and learn about offset provisions in purchase agreements.
M&A Stories
March 29, 2019
Introduction:
In the world of mergers and acquisitions, uncertainties loom even after the deal is sealed. How can buyers protect themselves from overpaying for a business? Beyond due diligence, buyers seek assurances from sellers regarding the business’s accuracy, particularly concerning financial records. These assurances are meant to reduce the risk of overvaluation.
But what if a seller’s claims about the business turn out to be untrue, and the business is valued lower than the agreed-upon purchase price? In such cases, where the buyer has already paid in full, seeking recourse can be challenging. The seller might dispute the inaccuracy, or they may lack the assets to refund the buyer.
How can buyers mitigate these risks? Two solutions stand out. First, a significant portion of the purchase price can be placed in escrow for a defined period, often around 18 months. Alternatively, buyers can delay part of the payment and reserve the right to offset damages resulting from the seller’s misrepresentations against this deferred amount.
The Deal:
Here’s a case in point: A buyer committed to purchasing a business for $1,175,000. They paid $175,000 in cash at closing and issued a $1 million note to the seller for the balance. The note allowed the buyer to offset note payments against any damages stemming from inaccuracies in the seller’s representations.
Following the closing, the buyer claimed that the business’s financial records were inaccurate, resulting in an undervaluation. Consequently, they stopped making note payments, citing the offset provision.
The Lawsuit:
The seller took the matter to a New York state court, seeking the outstanding balance on the note. The buyer defended their position, asserting their right under the note and purchase agreement to offset their damages against note payments.
The trial court sided with the buyer, emphasizing the importance of a buyer’s ability to offset losses arising from the seller’s breach of acquisition agreements against any obligations owed to the seller, such as note payments or noncompetition covenant fees.
Comment
It’s not uncommon for sellers to resist such offset provisions, arguing that buyers should not unilaterally decide whether a breach occurred. A common compromise involves stipulating that the buyer can’t exercise their offset rights if the seller disputes the breach until the matter is resolved through binding arbitration. However, buyers may be reluctant, as arbitration could result in delayed resolution and reduced available funds for offset.
Case Reference:
Borremans v. Gardner, Docket No. 651772/2018, Motion Seq. No. 001, Supreme Court, New York County, (March 18, 2019) https://scholar.google.com/scholar_case?case=16415870042329832312&q=%22membership+interest+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017
By John McCauley: I help businesses minimize risk when buying or selling a company.
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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