By: Doug McCullough
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Dealing with Buyer’s Remorse: What to do when Deals Go Wrong
The energy industry experienced a renaissance in recent years. The combination of hydraulic fracturing and GIS software led to remarkable expansion of US oil and gas production. Unfortunately, the industry has become the victim of its own success. The dramatic drop in oil prices in the past year have been the result of a glut of oil from overproduction. Mergers and acquisitions that made sense at 2013 oil prices may no longer make financial sense in hindsight when viewed in today’s price environment.
The mere fact that a buyer is disappointed with the results of an acquisition does not justify re-trading the deal. But, depending on the facts and circumstances surrounding the transaction and the terms of the deal as set forth in the purchase agreement, the buyer may have some remedies. This article explores some of the remedies that may be available to a buyer short of litigation or arbitration.
TYPICAL BUYER’S RIGHTS IN A PURCHASE AGREEMENT
An earn-out is a provision within a purchase agreement that makes a portion of the purchase price contingent on the acquired company reaching certain financial or non-financial milestones during a specified period after closing. The milestones may be tied to financial benchmarks such as gross or net revenue, net income, or EBITDA. An earn-out allows buyers and sellers to bridge the gap between their valuations of the target business. In practice, any consideration payable under the earn-out is contingent and deferred rather than paid at closing.
An earn-out enables a seller to participate in the continued appreciation of a growing company. An earn-out may make sense when the seller will continue to work in the business during the earn-out period. The potential risks of earn-outs for sellers can include:
Limited control over the operations of the business during the earn-out period;
Restricted access to the records of the business post-closing; and
Potential comingling of the acquired with buyer’s other businesses and assets enabling the buyer to manipulate the earn-out calculation.
From the buyer’s perspective, if the seller or its shareholders remain in the management of the acquired business, they may be in a position to manipulate the earnings of the acquired business. Dissatisfied buyers should review the financial statements of the acquired business to ensure that the management of the acquired business has not engineered cash flow or deferred prudent and necessary expenditures to manipulate the acquired business’s revenues.
Also, the buyer should consider whether it has provided funding or other assistance, including access to buyer’s resources or personnel, which would effectively understate the business’s costs and overstates net revenues. If so, buyer may have grounds to dispute the acquired business’s financial statements, or be able to impose proper and reasonable charges for the support given by buyer to the acquired business.
In a purchase agreement, the seller and seller’s shareholders often agree to certain covenants. The most common covenants involve promising not to use or disclose confidential information or to compete with the acquired business. If the seller or seller’s shareholders breach a covenant, the buyer may have a variety of rights including the right to a permanent injunction, monetary damages, as well as other remedies such as indemnification claims and set-off rights. The buyer’s remedies and procedures dispute resolution should be specified in the purchase agreement. A disgruntled buyer should revisit the covenants to determine whether all of the covenants have been met. If not, the buyer should calculate its economic damages from such breach of a covenant.
The typical purchase agreement will include page after page of representations and warranties made by the seller and/or seller’s shareholders. Essentially, the seller and/or seller’s shareholders are guaranteeing that the statements included in the representations and warranties are accurate and can be relied upon by the buyer. Typically, a failure to disclose a material fact will be treated like a misrepresentation.
In nearly all purchase agreements, the seller and/or seller’s shareholders will indemnify and hold harmless the buyer for any breach of a representation or warranty, as well as other losses to the buyer related to:
Failures by the seller to perform any covenant;
Pre-closing taxes of the acquired company;
Excluded liabilities (i.e., liabilities of the target company specifically not assumed by the buyer);
Employee benefits for employees that did not transfer to the buyer;
Infringement by the seller or its technology on the intellectual property rights of a third party; or
Any liabilities of the seller or its business arising prior to closing.
When a buyer has not gotten what it bargained for, it should inquire whether it has suffered an indemnifiable loss.
A buyer’s damages are sometimes calculated using the benefit of the bargain standard. The concept is that damages should be measured by determining the difference between the value of the company as warranted by the seller and its true value at the time of the transaction.
It is common for the purchase price of a company to be determined by applying a multiple to the companies EBITDA (i.e., Earnings Before Interest, Taxes, Depreciation and Amortization). For instance, the parties may agree to a purchase price that is six times EBITDA. In such situations, seller’s representations and warranties that touch on EBITDA become critical. Any seller misrepresentation that overstates EBITDA would theoretically cause buyer damages that are six times the amount of the specific item being misstated.
Thus, when making an indemnification claim for a seller’s breach of representation or warranty, buyer should determine whether (i) the purchase agreement allows damages to be calculated based on the benefit of the bargain standard, and (ii) the misrepresentation materially affects the value of the acquired business as of the time of the transaction.
It is quite common for the purchase price to be paid in installments or by means of a promissory note that will be paid off by the buyer over time. In such cases, buyer may have the self-help remedy to offset any indemnification claims against payments it otherwise may owe to the seller. The purchase agreement will likely include terms governing disputes between buyer and seller over indemnification claims and set-off rights. Often, the buyer is empowered to deduct and withhold the amount of an indemnifiable claim from amounts owed to the seller until the dispute over such indemnification claim is resolved.
Many acquisitions involve holding back a portion of the purchase price in an escrow that is available to fund any post-closing indemnification claims during the term of the escrow. The escrow is typically set up with a formal escrow agreement and a commercial bank acting as the escrow agent. If the buyer has an indemnification claim, the agent will likely require the buyer and seller to jointly sign written instructions releasing funds to the buyer to pay the indemnification claim. Upon the lapse of the escrow term, the escrow agent will release the remaining funds to the seller.
If a buyer is exploring whether it has any indemnification claims against a seller, it should be mindful of the term of the escrow and any time limits on raising indemnification claims.
REEXAMINE THE DISCLOSURE STATEMENTS
Just because a buyer is dissatisfied with the results of a transaction does not justify either litigation or renegotiating a deal. However, a properly drafted purchase agreement would include several rights and remedies for the buyer. If the buyer did not get the deal it bargained for at the time of the transaction, the buyer should reexamine the purchase agreement to determine its right and seller’s disclosure schedules to determine seller breached any representations and warranties. Depending on the terms of the deal and the fact and circumstances, the buyer may have some remedies short of resorting to litigation or arbitration.
Doug McCullough | McCullough Sudan, PLLC | firstname.lastname@example.org | https://dealfirm.comшарапова теннис сегодня