Navigate the complexities of M&A with insights into mitigating hidden risks in vendor contracts. This article dissects a recent case highlighting the dangers of undisclosed conflicts of interest involving a target company’s insiders and key service providers. Learn practical pre-closing strategies for buyers, sellers, and advisors in the lower middle market, focusing on the crucial role of representations, warranties, and due diligence in safeguarding against post-acquisition legal disputes. Understand how to structure deals and negotiate contractual provisions to address unseen ties that could impact your M&A transactions.
M&A Stories
April 11, 2025
Unseen Ties: Mitigating Conflict of Interest Risks in M&A Vendor Relationships
Acquiring a business often entails stepping into the target’s existing operational framework, which invariably includes contracts with key vendors. However, the seemingly straightforward transfer of these agreements can be complicated by hidden affiliations, as a recent legal case illustrates. The matter underscores the critical importance of proactive measures to identify and address potential conflicts of interest involving a target company’s insiders and its essential service providers.
Consider a scenario where a buyer agreed to acquire a medical billing firm specializing in radiology services. The target company’s operations were heavily reliant on a specific software platform provided by a third-party vendor, a system integral to its core billing processes. Unbeknownst to the buyer, the target company’s chief executive officer held a significant personal financial stake in this very software vendor. This conflict of interest remained undisclosed throughout the negotiation and sale process, hidden from both the selling shareholders and the acquiring entity.
Following the agreement on acquisition terms, the software vendor initiated litigation related to the deal. The target’s CEO then played a role in facilitating a settlement, an arrangement that obligated the buyer to continue using the vendor’s platform for an extended period post-acquisition, with associated payments. Crucially, the buyer remained unaware of the CEO’s financial entanglement with this key vendor during this period.
The undisclosed conflict eventually surfaced, prompting the buyer to pursue legal action against the selling shareholders, alleging vicarious liability for the CEO’s fraudulent concealment. Ultimately, a jury sided with the sellers on this claim.
While the specifics of due diligence vary, the facts of this case suggest that standard buyer inquiries might not have unearthed the CEO’s hidden interest. However, this outcome highlights a crucial pre-closing strategy: the inclusion of a robust representation and warranty within the acquisition agreement. Buyers should insist on an explicit assurance from the selling shareholders that no owner, officer, or key employee of the target company holds any direct or indirect financial interest in any of the target’s material vendors, suppliers, or customers. A carefully crafted exception could be carved out for de minimis, passive holdings in publicly traded entities. Furthermore, the acquisition agreement should include a clear indemnification provision obligating the sellers to compensate the buyer for any losses arising from a breach of this representation.
Such a contractual provision serves as a vital safeguard, shifting the responsibility of disclosure to the sellers and providing a recourse for the buyer should undisclosed conflicts of interest materialize post-closing. While thorough due diligence remains paramount, specific and well-negotiated representations and warranties offer a critical layer of protection against hidden risks that might otherwise remain unseen until litigation ensues.
See: Zotec Partners, LLC v. Hulsey Court of Appeals Case No. 24A-PL-870, Court of Appeals of Indiana, (April 8, 2025).
Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.
Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law.
By John McCauley: I write about recenegal problems of buyers and sellers of small businesses.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my books: Buying Established Business Assets: A Guide for Owners, https://www.amazon.com/dp/B09TJQ5CL5
and Advisors and Selling Established Business Assets: A Guide for Owners and Advisors, https://www.amazon.com/dp/B0BPTLZNRM
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