Explore a recent legal case highlighting challenges in M&A transactions when business sellers fail to pay critical vendor invoices. Learn how clear agreements and meticulous contract drafting can prevent uncertainties and potential conflicts. Case reference: Continental Motors, Inc. v. Danbury Aerospace, Inc.
April 16, 2020
Introduction:
In the process of acquiring a business, the division of seller’s liabilities between the buyer and seller is a common practice. However, a potential challenge arises when the seller fails to settle a retained liability owed to a critical vendor or supplier after the business transfer. To mitigate this risk, buyers often secure the right to make payments to these vendors and then seek reimbursement from the seller. A recent legal case sheds light on such scenarios, emphasizing the importance of clear agreements.
The Deal:
In a recent case involving the purchase of operating assets from an aircraft engine manufacturer, the purchase price included $2.4 million held in escrow. This escrow was designed to safeguard the seller’s commitments outlined in the asset purchase agreement (APA). According to the APA terms, the buyer took responsibility for specified trade payables from the seller, up to a total of $1 million. Any payables exceeding this amount were the seller’s responsibility.
Interestingly, the APA also granted the buyer the discretion to pay excessive payables if it deemed it necessary to maintain crucial business relationships. The agreement allowed the buyer to make these payments if the seller neither promptly settled nor disputed the payables. In such instances, the seller was obligated to reimburse the buyer upon request, and if failed to do so, the buyer could obtain reimbursement from the escrow fund.
The Lawsuit:
Subsequently, the buyer found itself making payments for what it believed were excess payables involving critical vendors that hadn’t been settled or disputed. Despite these payments, the seller neither reimbursed the buyer nor released funds from escrow to cover these expenses. This dispute escalated to a Texas state trial court, where the seller sought a summary judgment motion, essentially aiming to dismiss the buyer’s claim to the escrow funds. The trial court sided with the seller.
However, the buyer appealed, leading to the intermediate appellate court overturning the decision and returning the case to trial court for further proceedings. The key point of contention centered on whether the buyer’s payments were eligible for reimbursement from the escrow fund based on the terms of the APA.
Appellate Court Ruling:
The seller’s argument on appeal was that reimbursement from the escrow fund was only possible if the buyer had first confirmed that the seller had neither paid nor disputed the excessive payables. The appellate court agreed with this interpretation, stating that the buyer’s discretion to pay hinged on the seller’s lack of payment or dispute.
However, the appellate court also acknowledged evidence suggesting that the buyer may have based its decisions on prior communications with the seller. There were instances where the seller might have chosen not to pay or dispute the payables, instructing the buyer to handle the payment instead or add the amount to the escrow account. Given this uncertainty, the appellate court concluded that the seller had not conclusively proven that the buyer wasn’t entitled to reimbursement from the escrow fund. Thus, the seller’s claim for judgment as a matter of law was unsuccessful.
Conclusion:
The case highlights the complexities surrounding escrow fund disputes in asset acquisitions. To enhance clarity, it’s suggested that the APA include explicit language indicating that the buyer’s failure to determine the status of an excess payable shouldn’t impede their right to reimbursement, provided the payable was indeed unpaid or disputed. This case underscores the importance of meticulous contract drafting to avoid uncertainties and potential legal conflicts.
Case Reference:
This case is referred to as Continental Motors, Inc. v. Danbury Aerospace, Inc., No. 04-19-00059-CV., Court of Appeals of Texas, Fourth District, San Antonio (Delivered and Filed: April 1, 2020).
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