Explore a recent M&A case where a buyer’s bankruptcy reorganization led to the elimination of an earnout obligation in the purchase of cloud-based secure messaging IP. Learn about the legal implications and key takeaways from this situation.
M&A Stories
March 20, 2023
Introduction
In this blog post, we discuss a case where a buyer purchased a seller’s cloud-based secure messaging intellectual property (IP) with a royalty-based earnout. However, due to the buyer’s bankruptcy reorganization, the earnout obligation was eliminated.
The deal
The seller sold their leading cloud-based secure messaging and enterprise data integration platform to the buyer. As part of the purchase price, a substantial earnout based on royalties was included.
The Bankruptcy Situation: A year later, the buyer filed for Chapter 11 bankruptcy protection. During the bankruptcy proceedings, certain contracts were assumed by the buyer, while others were rejected. The rejected contracts did not include any related to intellectual property contracts, licenses, royalties, or similar agreements.
The lawsuit
After the bankruptcy court confirmed the buyer’s bankruptcy plan, the seller sought a declaration that the earnout provision in the purchase agreement had been assumed by the buyer, given that it was a royalty. However, the bankruptcy court denied this motion, ruling that the buyer only assumed ongoing intellectual property arrangements crucial to the business. The earnout was deemed deferred compensation for assets already transferred in full, rather than a royalty. The seller appealed to the federal district court and court of appeals but was unsuccessful.
See QMAX, Inc. v. Fusion PM Holdings, Inc., https://casetext.com/case/iqmax-inc-v-fusion-pm-holdings-inc-2, United States Court of Appeals, Second Circuit (March 1, 2023).
Comment
This case serves as a reminder that when selling a business, there is a significant risk that the seller may not receive the remaining portion of the purchase price if it is not paid at closing.
By John McCauley: I write about recent legal problems of buyer 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
Podcasts https://www.buzzsprout.com/2142689/12339043
Check out my books: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles and Selling Assets of a Small Business: Problems Taken From Recent Legal Battles
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