Buyer allocates time and expense to fix a product design problem identified by a customer
M&A Stories
September 3, 2021
Introduction:
In M&A deals, representations and warranties in purchase agreements play a crucial role in determining the allocation of risk between the buyer and the seller. A recent case highlights the significance of such agreements when a buyer discovers a product design problem after purchasing a manufacturing business.
The Deal:
In this particular case, the buyer acquired the assets of a manufacturing company that specialized in chemical calibration devices, including permeation tubes and calibration gas standard generators. These devices allowed customers to calibrate their chemical analyzers and other instruments accurately. The seller also offered standardized instruments for approximately 600 different chemicals, which could be customized to meet customer needs.
The Lawsuit:
After the purchase, the buyer encountered a product design issue with one of the acquired products, specifically, a device designed to create a humidity-based calibration standard. When the buyer sold this device to a customer, it was reported that the product was not functioning correctly. At the seller’s direction, the buyer engaged a third-party company to resolve the issue, resulting in financial losses totaling $33,439, including costs for the third-party service, in-house expenses, materials, and warranty claims.
The seller had given a representation and warranty in the asset purchase agreement, stating that their products were free from design defects that would hinder proper performance, function, and compliance with published specifications. However, this statement proved to be inaccurate.
The Verdict:
A Texas state jury ruled in favor of the buyer, holding the seller accountable for the breach of the representation and warranty. Subsequently, the seller appealed the decision to an intermediate appellate court but failed to overturn the ruling.
The Importance of Representation and Warranty:
The buyer emphasized the significance of the seller’s representation and warranty, asserting that defects in product design could lead to malfunctioning products and compromised long-term reliability. The buyer admitted that during the due-diligence process, it was challenging to detect design defects, making the representation and warranty a critical tool to manage legal risks in M&A transactions.
This case is referred to as McKinley v. Kin-Tek Analytical, Inc., No. 01-19-00642-CV, Court of Appeals of Texas, First District, Houston, (Opinion issued August 5, 2021).
Takeaway:
This case serves as a valuable lesson for all parties involved in M&A deals. Properly crafted representation and warranty in purchase agreements can protect the buyer from potential risks and financial losses resulting from undisclosed product defects. Thorough due diligence is essential, but in some cases, relying on strong representations and warranties may be the only feasible way to mitigate M&A legal risks.
By John McCauley: I help people manage M&A legal risks.
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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