The subordination agreement entitled the bank to be paid ahead of the seller unless the buyer met certain financial conditions designed for the bank’s security
M&A Stories
April 11, 2022
Introduction:
Selling a business involves the risk of nonpayment for the deferred portion of the purchase price, especially when the buyer’s obligation is subordinated to their bank. In this blog, we explore a case where a business seller faced difficulties in collecting payment from the buyer’s guarantor due to a subordination agreement.
The Deal:
The seller agreed to sell their business to the buyer, with part of the purchase price consisting of a $2 million promissory note from the buyer. This note was guaranteed by an individual, likely the buyer’s owner. The buyer’s bank was also involved in the transaction. As part of the deal, the seller signed a subordination agreement, allowing the bank to be paid first, ahead of the seller, unless the buyer fulfilled specific financial conditions designed for the bank’s security.
The Lawsuit:
Unfortunately, the buyer failed to make the scheduled note payments. Subsequently, the buyer sued the guarantor to collect the remaining balance on the note. However, both the trial court and the appellate court ruled against the seller. They held that the seller was not entitled to payment from the buyer or the guarantor under the note, due to the conditions in the subordination agreement. According to the agreement, the seller could only receive payment if the bank had been paid or if the buyer met certain financial conditions set to protect the bank’s interests. Since neither of these conditions had been met, the seller couldn’t collect the payment.
This case is referred to as Indigo Old Corp., Inc. v. Guido, No. 21-1922, United States Court of Appeals, Seventh Circuit, (Decided March 28, 2022.)
Comment:
When a seller agrees to a deferred purchase price, there’s always a risk involved. This risk becomes more significant when the deferred purchase obligation is subordinated to the buyer’s obligations to their bank. It’s crucial for sellers to carefully consider the terms of such agreements and the potential impact on their ability to collect payments.
By John McCauley: I write about recent legal 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 book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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