Explore a significant M&A dispute involving a Palo Alto company and the key lessons learned from this case. Understand the importance of addressing debt subordination in M&A deals to avoid costly disputes.
M&A Stories
December 13, 2018
In December 2018, a significant M&A dispute unfolded involving a Palo Alto company specializing in electro-plating for industrial use. The buyer acquired the company’s stock for $9.3 million, with a payment structure of $2 million at closing, a $3.5 million post-closing installment payment, in monthly installments until the buyer could obtain financing for the balance of the post-closing down payment, and this balance subject to purchase price adjustments, and a $3.8 million promissory note to cover the balance.
Eight months after the transaction, the buyer sought the seller’s subordination of the remaining debt to a bank, which was a condition for bank financing of $1.5 million post-closing down payment, the amount reduced by buyer for purchase price adjustments. However, the seller declined this request, as subordination had never been discussed during negotiations, and the seller had insisted on securing first-lien priority on their debt.
The dispute eventually reached a federal district court in San Jose, with the buyer claiming a breach of the implied covenant of good faith and fair dealing. The buyer argued that the seller’s refusal to subordinate their debt violated the stock purchase agreement’s requirement to execute necessary documents to facilitate the transaction.
However, the court ruled in favor of the seller, stating that there was no explicit provision in the stock purchase agreement obligating the seller to subordinate their debt to the bank. Furthermore, the proposed bank financing would have left a substantial balance due to the seller subordinated to the bank, which raised concerns given the company’s past failure to make timely payments.
In the end, the court found the seller’s refusal to subordinate reasonable under the circumstances and noted that it did not harm the company’s rights under the stock purchase agreement, as it had the right to pay the post-closing down payment in monthly installments if it could not finance the payment.
This case highlights the importance of considering debt subordination in M&A deals, as addressing such issues upfront can prevent costly disputes and potential fallout.
Case Reference:
Hammon Plating Corporation v. Wooten, Case No. 16-CV-03951-LHK, United States District Court, N.D. California, San Jose Division, (September 25, 2017). https://scholar.google.com/scholar_case?case=8845586872299363938&q=%22stock+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017
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