Explore a case study of M&A gone awry due to employment contracts with arbitration clauses. Learn key takeaways for smoother transactions.
M&A Stories
March 8, 2019
Introduction:
In the world of M&A, buyers often want the previous owners to stick around post-acquisition. To make this happen, they sign employment agreements alongside the main purchase agreement. These employment agreements frequently contain arbitration clauses. Although many purchase agreements lack such clauses, they often refer to the employment agreement as part of the overall deal.
The Deal:
In this case, the seller was a construction company with expertise in patented technology that mitigates liquefaction during earthquakes. Instead of owning the technology, the seller had an exclusive license from the technology’s owner.
In 2015, the seller sold its business to the buyer, who was also the licensor of the technology. As part of the deal, the seller’s owner agreed to work for the buyer and signed an employment agreement with an arbitration provision. The purchase agreement explicitly stated that the employment agreement was part of the entire agreement. However, the asset purchase agreement itself did not include an arbitration provision.
The Trouble:
Unfortunately, the deal didn’t go as planned. The buyer did not pay anything upfront for the seller’s goodwill; instead, they agreed to capture the goodwill through an earnout arrangement in the employment agreement, based on profits from the purchased business. Regrettably, the earnout never materialized, and the seller’s owner left the buyer’s employment in August 2017.
The Legal Battle:
A year later, the seller’s owner took the buyer to court in South Carolina, alleging that the buyer had undermined the earnout through accounting practices and management decisions. The buyer asked the court to compel arbitration per the employment agreement, even though the asset purchase agreement lacked an arbitration clause. The seller’s owner argued that the dispute was fundamentally about the sale of his company and that the asset purchase agreement didn’t mention arbitration.
The Outcome:
Despite the absence of an arbitration clause in the asset purchase agreement, the court ruled in favor of arbitration. It cited the purchase agreement’s language, which incorporated the employment agreement, including its arbitration provision.
Key Takeaways:
Two essential lessons emerge from this case:
1. Secure Cash at Closing: When selling your company, aim to receive your payment in cash during the closing rather than relying on the buyer to fulfill future earnout agreements.
2. Arbitration Consideration: Understand that once an arbitration clause is included in an employment agreement, it can be challenging to reverse its effects, even if the asset purchase agreement lacks such a provision.
Case Reference:
Ellington v. Hayward Baker, Inc, No. 2:18-cv-3436-DCN, United States District Court, D. South Carolina, Charleston Division, (February 28, 2019).
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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