Explore the key considerations and risks associated with acquiring assets in M&A deals involving buyer equity. Learn how successor liability risks can be effectively mitigated, with insights from the Credit Card Services, Inc v. Joe Teh Chuang case.
M&A Stories
October 2, 2023
Introduction:
When purchasing a business’s assets with cash, a buyer’s exposure to unassumed seller liabilities is typically limited. However, the landscape changes when the purchase price includes buyer equity. In this blog post, we explore the key considerations and risks associated with acquiring assets in such scenarios.
The Background:
In this case, a national company (referred to as “the competitor”) specialized in providing credit card processing services. Concurrently, a California-based company (referred to as “the seller”) was established by former employees of the competitor, who admittedly operated with stolen confidential information.
The competitor had a long-standing history as a registered ISO, enabling it to offer credit card services for major brands like VISA and Mastercard. Over time, it expanded its reach from Korean-speaking to Vietnamese- and Chinese-speaking merchants, with branch offices across the United States.
To protect its interests, the competitor had employed sales representatives who signed contracts prohibiting the use or disclosure of proprietary information, solicitation of competitor customers, or poaching of competitor employees. This proprietary information included merchant lists, customer data, pricing details, and more, all considered as highly confidential trade secrets.
In 2011, the El Monte sales reps and a San Francisco sales rep left the competitor and founded the seller, directly competing with their former employer. The seller, being an unregistered sub-ISO, had to collaborate with a registered ISO to operate.
In 2015, the buyer’s parent company, a registered ISO and competitor of the competitor, acquired the seller’s assets through a subsidiary (referred to as “the buyer”). The purchase price comprised buyer equity and the assumption of certain debts owed by the seller to the buyer’s parent. Importantly, the buyer group was aware of a 2012 lawsuit filed by the competitor against the seller group, which they did not assume as a liability.
Legal Proceedings:
In June 2012, the competitor initiated a lawsuit against its former El Monte sales reps and the seller in a California state trial court. The competitor alleged that the former sales reps had used its protected trade secrets, including confidential customer lists and merchant files, to develop the seller. Furthermore, it was claimed that one of the former reps recruited the San Francisco sales rep using the competitor’s confidential information.
The competitor’s legal action included claims of breach of contract, misappropriation of trade secrets, and other related charges stemming from this conduct. The seller and its owners acknowledged liability, and the buyer was brought into the lawsuit under the theory of successor liability, specifically through the doctrines of de facto merger and mere continuation.
Outcome:
Ultimately, the trial court ruled that the buyer had no liability to the competitor under the concept of successor liability. This decision was upheld on appeal to the intermediate appellate court. The court noted that the purchase price paid for the assets was more than sufficient, minimizing any potential liability.
Comment:
This case underscores a crucial point for M&A asset deals involving buyer equity. Successor liability risks can be effectively mitigated if the purchase price for the assets is deemed adequate, as demonstrated in this case.
Case Reference:
See Credit Card Services, Inc v. Joe Teh Chuang, No. B306223, Court of Appeals of California, Second District, Division Three (Filed August 31, 2023).
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
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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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