Dive into the legal intricacies of M&A deals with our latest blog post exploring the liability of parent companies in acquisitions. Uncover valuable lessons from a recent legal battle and learn about the risks involved in forming acquisition subsidiaries. Discover how meticulous planning and due diligence are imperative for navigating the complex landscape of mergers and acquisitions.
M&A Stories
May 14, 2018
In the world of mergers and acquisitions, the intricacies of forming acquisition subsidiaries can sometimes lead to unexpected legal entanglements. Such was the case in a recent legal dispute, shedding light on the risks involved when embarking on business acquisitions.
Picture this scenario: an established operating company, which we’ll refer to as Parent, sets its sights on acquiring the business assets of another entity, Seller. To facilitate the acquisition, Parent creates a fresh acquisition subsidiary, aptly named Buyer. The deal is inked, agreements signed, but then things take an unexpected turn.
Buyer, the newly formed subsidiary, finds itself unable to honor its financial commitments to Seller, defaulting on substantial payments as outlined in the asset purchase agreement. Seller, understandably aggrieved, takes legal action against Buyer. However, with Buyer lacking sufficient assets to fulfill its obligations, Seller turns its attention to Parent, seeking recourse.
Parent, having not been a direct party to the initial asset purchase agreement, attempts to distance itself from the legal fray, arguing for dismissal of the lawsuit. But the court’s verdict delivered a stark reality check. It ruled that Parent could indeed be held liable for Buyer’s debts if it failed to adequately capitalize the subsidiary.
The crux of the matter lay in whether Buyer, the acquisition subsidiary, had been sufficiently funded to meet its financial obligations. Allegations surfaced suggesting that Parent had formed Buyer without adequate capitalization, essentially using it as a shield to insulate itself from liability while reaping the benefits of Seller’s assets.
This legal precedent serves as a cautionary tale for businesses venturing into acquisitions through subsidiary structures. While the formation of acquisition subsidiaries is a common strategy to safeguard parent companies from creditors’ reach, it’s not foolproof. The crucial question of adequate capitalization remains subjective and open to legal dispute, leaving parent companies vulnerable to lawsuits alleging insufficient funding of subsidiaries.
In essence, the case underscores the importance of meticulous planning and due diligence in M&A transactions. While the allure of acquisition may be enticing, it’s imperative for businesses to navigate these waters with prudence and foresight, mindful of the potential legal pitfalls that could ensnare them.
Case Reference: Scallop Imaging, LLC v. Blackhawk Imaging, LLC, Dist. Court, D. Massachusetts 2018 Civil Action No. 17-cv-10092-ADB, and can be found at: https://scholar.google.com/scholar?scidkt=15237134566953886767&as_sdt=2&hl=en
By John McCauley: I help people start, grow, buy and sell their businesses.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
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Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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