Explore the intricacies of indemnification claims in M&A through a cautionary tale of a private equity firm’s acquisition of an environmental remediation company. Learn from the legal challenges, court rulings, and the importance of setoff provisions in stock purchase agreements.
M&A Stories
October 11, 2018
In the dynamic world of M&A, strategic planning is crucial to navigate post-closing challenges. This narrative revolves around a private equity firm’s acquisition of a New Orleans-based environmental remediation company, highlighting the intricacies of indemnification claims.
Background:
On March 31, 2014, a private equity firm (buyer) acquired the stock of an environmental remediation company (target) from another private equity firm (seller) for approximately $100 million. The stock purchase agreement outlined various representations and warranties, covering the target’s financial condition, liabilities, and customer relationships.
Post-Closing Revelations:
After the deal closed, the buyer alleged that the seller had made false statements about the target’s financial reporting, systems, and growth prospects. Specifically, discrepancies were identified in the target’s financial records, with expenses omitted and revenue overstated, resulting in an inflated purchase price of over $23 million.
Legal Actions Unfold:
In 2015, the buyer initiated a lawsuit against the seller in a New York State court, seeking indemnification for breaches of the stock purchase agreement. A year later, while the buyer’s lawsuit was ongoing, the seller filed a separate action in the same New York court, aiming to obtain $2.8 million in pre-closing tax refunds from the target.
Key Challenge:
The buyer, despite acknowledging the $2.8 million pre-closing tax refunds payable to the seller, refused to release the funds. This refusal was based on the buyer’s larger indemnification claim against the seller.
Legal Outcome:
The court ruled in favor of the seller, emphasizing the absence of a provision in the stock purchase agreement allowing the buyer to offset the seller’s refunds against its indemnification claim.
Lesson Learned:
The case underscores the importance of including setoff or offset provisions in stock purchase agreements. Such provisions grant buyers the right to offset indemnification claims against post-closing payment obligations, such as deferred purchase prices, noncompetition or consulting payments, and prorated tax refunds.
This cautionary tale emphasizes the need for meticulous planning in M&A transactions to mitigate risks and ensure a smoother post-closing transition.
Case Reference:
Cricket Stockholder Rep, LLC v. Project Cricket Acquisition, Inc., Docket No. 651454/2016, Motion Seq. No. 001, Supreme Court, New York County (May 10, 2018). https://scholar.google.com/scholar_case?case=4864837335428147567&q=%22stock+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017#r[1]
By John McCauley: By John McCauley: I help people manage their tax risk when buying or selling a business.
Email: jmccauley@mk-law.com
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