Explore a recent M&A case where a seller accused the buyer of manipulating earnings to avoid the earnout. Dive into the legal intricacies and lessons learned from Main Market Partners, LLC v. Olon Ricerca Bioscience LLC.
M&A Stories
May 16, 2019
Introduction:
In the world of mergers and acquisitions, sellers aim for the highest cash price at closing, while buyers often seek assurance that they’re not overpaying. So, how can these conflicting interests be reconciled? One solution is the earnout, a payment structure based on post-closing business performance, typically measured by metrics like EBITDA in the first year after the deal. This blog delves into a recent case where a seller accused the buyer of manipulating earnings to avoid the earnout.
The Deal:
Our story revolves around an Akron-based private equity firm specializing in distressed middle-market companies. They owned a chemical division, which they sold to an Italian chemical firm subsidiary for $8.4 million in cash at closing and assumed $18.6 million of seller debt. Additionally, the buyer agreed to pay a $5.5 million earnout if the chemical division met a specified EBITDA target during the first post-sale year. The catch: the buyer committed in the asset purchase agreement not to take any bad-faith actions to dodge the earnout.
The Lawsuit:
Unfortunately, the business didn’t reach the earnings target, resulting in no earnout payment to the seller. This led to a lawsuit in an Ohio federal district court. The seller accused the buyer of manipulating earnings and revenue to avoid the earnout. The buyer countered that even if the seller’s allegations were true, they didn’t constitute a breach of the promise not to act in bad faith.
The Court’s Decision:
The court sided with the seller, stating that these allegations could indeed establish bad faith. The seller’s accusations included steering chemical division business to the buyer’s Italian parent company, delaying customer payments, incurring $3 million in unjustified strategic costs during the earnout period, failing to properly track and account for these costs, and obscuring them. As a result, the seller was allowed to proceed with the litigation.
Comment:
This case underscores the inherent risks in earnout deals, where sellers relinquish control of the business. It serves as a reminder that it might be prudent to consider a smaller upfront payment at closing rather than a larger deferred sum dependent on buyer performance.
Case Reference:
Main Market Partners, LLC v. Olon Ricerca Bioscience LLC, Case No. 1:18-CV-916, United States District Court, N.D. Ohio, (April 9, 2019) https://scholar.google.com/scholar_case?case=4976259500205573361&q=%22asset+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017#r[17]
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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