KEN KIRSCHENBAUM, ESQ
ALARM - SECURITY INDUSTRY LEGAL EMAIL NEWSLETTER / THE ALARM EXCHANGE
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More on standard provisions in buy-sell agreements / congrats on selling, welcome to nightmare litigation
August 16, 2021
More on standard provisions in buy-sell agreements / congrats on selling, welcome to nightmare litigation from articles on July 13 and 19, 2021
First of all, if you missed the first two articles on this topic circulated on July 13 and on July 19, 2021, go to K&K website and read them: https://www.kirschenbaumesq.com/page/alarm-articles
The article focused on the buy –sell agreement between alarm companies, particularly on a provision that permitted the parties to close and then “adjust” the purchase price sometime after closing [I’ve seen 15 days to 6 months]. I suggested that you would be foolish to accept an argument that this provision, or most provisions, are “standard provisions” in a buy- sell agreement. A buy-sell agreement comes in two types, the APA, asset purchase agreement, and the SPA, the stock purchase agreement. A provision that permits adjustment of the purchase price for anything other than application of the guarantee [for attrition] or indemnity [for non-disclosed trade or other liability] is definitely not “standard”; it’s not “customary” and I’ve never asked for it and I’ve never agreed to it. You’d be dumb to agree to it.
Here’s someone dumb enough to agree to it:
A lawsuit has been commenced in Colorado between a buyer of the sellers’ interest in an LLC [so this is a SPA, not an APA]. As an aside, you have to be particularly careful with a SPA because the buyer is stepping into the shoes of the seller, taking over the corporate entity, assets and liabilities. In a SPA the buyer must do far more due diligence than would be required in an APA [even though some buyers can’t seem to get that distinction right]. But due diligence is required in an APA too; enough due diligence to establish a purchase price.
Just imagine. Let me buy your car and drive it for 6 months. I’ll pay you $50,000 when you give me the keys. After 6 months I’ll let you know what I don’t like about the car and let you know how much money you need to pay me back. If we can’t agree on the amount we can [and now this is unbelievable – really – because the “transactional lawyers’ came up with this – we each hire an accountant; if they can’t agree; they hire an accountant; if we don’t agree we can go to court. Buyer is in Oregon, seller in Illinois and the litigation is in Delaware.]
Getting back to why I am on this topic again. So a lawsuit is commenced in Colorado by an Oregon alarm company who buys the LLC interest in alarm business in Colorado. Here are few excerpts from the Complaint that was filed:
13. Section 1.2 of the LLC Membership Purchase Agreement provided, “[t]he Purchase Price for all of the Units shall be determined as follows (as of the close of business on the day immediately preceding the Closing Date (the “Measure Date”): the product obtained by multiplying the amount of the company’s QRMR (defined in Section 1.5) by 48.75.”
14. Section 1.2.1 of the LLC Membership Purchase Agreement provides that the parties agreed to utilize, “an estimated total Purchase Price of Twenty-One Million Dollars ($21,000,000.00) (the "Estimated Purchase Price"),” for Closing, which would be “adjusted to reflect the actual Purchase Price pursuant to the provisions of Article 1.6.” 15. Section 1.3 of the LLC Membership Purchase Agreement provided that the purchase price for the shares was to be paid in a combination of cash payments, “Buyer Notes,” and assumption of liabilities and debts.
16. Section 1.5 of the LLC Membership Purchase Agreement defined QRMR as follows: “the sum to be derived by the Company from all charges which would be payable to the Company by its customers with accounts under contract for alarm monitoring services (“Accounts”) to be furnished to them by the Company during the month next following the date on which the calculation of QRMR is made. Any prepayments, credits, discounts or other similar adjustments applied by the Company before the Measure Date as it pertains to any such accounts shall be valued for QRMR purposes as is otherwise provided in this Agreement.”
The agreement excluded certain charges from the purchase price calculation; not relevant here except that it’s obvious that the buyer didn’t bother to do a very good job at due diligence to figure out what to exclude from the 21 million dollar purchase price. Why do I say that? Well here is the “standard provision” which is the focus of this article, and which you would be an idiot to sign, whether you’re a buyer or seller.
“18. Article 1.6 of the LLC Membership Purchase Agreement, which governed the adjustment of the purchase price, provided that: Within one hundred twenty (120) days after the Closing Date, Buyer shall deliver to Administrative Sellers and Minority Sellers a statement (the “Final Purchase Price Statement”) setting forth Buyer's calculation of the actual Purchase Price calculated pursuant to the provisions of Articles 1.2 and 1.5 hereof (the “Final Purchase Price”). Buyer shall give representatives of Administrative Sellers and Minority Sellers reasonable access to the premises of Buyer, to its books and records and to the appropriate personnel of Buyer for purposes of confirming the Final Purchase Price Statement. Unless an Administrative Seller or Minority Seller notifies Buyer in writing that such person disagrees with the Final Purchase Price Statement within Sixty (60) days after receipt thereof, the Final Purchase Price Statement shall be conclusive and binding on Buyer and Administrative Sellers and Minority Sellers. If an Administrative Seller or Minority Sellers notifies Buyer in writing of a disagreement with the Final Purchase Price Statement within such 60- day period, then Buyer and such person shall attempt to resolve their differences with respect thereto within thirty (30) days after the Buyer's receipt of the written notice of disagreement. Any dispute regarding the Final Purchase Price Statement not resolved within such 30-day period will be resolved by an accounting firm mutually acceptable to both parties or, in the absence of agreement, by an accounting firm of regional reputation selected by lot after eliminating Minority Sellers', Administrative Sellers' and Buyer's principal outside accountants. The determination by the accounting firm so selected of the Final Purchase Price Statement and the Final Purchase Price (with such modifications therein, if any, as reflect such determination) shall be conclusive and binding upon all of the Buyer, Minority Sellers and Administrative Sellers. The fees and expenses of such accounting firm in acting under this Article 1.6 shall be shared equally by Buyer and the objecting party. 19. Article 1.6.2 of the LLC Membership Purchase Agreement further provided, “[i]f the Estimated Purchase Price is greater than the Final Purchase Price then the principal balance of the Buyer Notes issued to the Administrative Sellers set forth in Section 1.3(e) shall be decreased accordingly.”
Now in this case there appears to be a Promissory Note, so not all of the Purchase Price was paid at closing. Good thing for buyer. But consider:
* If you’re the buyer you pay at closing and you then have to chase the buyer for reimbursement once the reduction in purchase price is agreed to or determined by a judge
* If you’re the seller, you close, sell your business, retire, plan on paying taxes on your gain and maybe spending the rest, only to find out 6 months later that your purchase price is going to be cut in half. Say what?
Look, when you close you need to know the purchase price. There are two permitted exceptions:
* The first is the guarantee of the accounts. Most deals provide for a guarantee and then collateralize the guarantee by a fund, referred to be a Hold Back. [some geniuses have come up with other ways to describe this arrangement – avoid them too]. Typically the Hold Back is not paid until after the guarantee period is over and the purchase price is adjusted. This arrangement is less offensive to sellers because they never got the Hold Back and they know that there is likely to be some attrition so they know they aren’t getting the entire Hold Back. Buyers like it because they know the purchase price is likely to be reduced and they don’t have to post the money while the guarantee is running.
* The second exception to a change in purchase price is when there has been, essentially, a misrepresentation by the seller. Seller represents that it has no outstanding liability that will affect the buyer, such as owing the central station, phone or radio vendors or a whole lot of outstanding warranty and promised service issues. Despite due diligence the buyer doesn’t discovery the misrepresentations. The buyer is entitled to reimbursement and the contract, APA or SPA, is likely to provide for indemnity by seller to buyer. This indemnity, unlike the guarantee against attrition, is not collateralized, typically.
So there you have it. Still confused? Well hire K&K for your transactional matter and we will steer you right. Want a head start on understanding all the issues on a buy-sell deal, get the Standard DIY Asset Purchase Agreement [long or short form], where you will find some “standard provisions”. In the hundreds of alarm deals I’ve handled I don’t think one has resulted in litigation. That’s important information because whether you’re buying or selling you want to get on with your business and life, you don’t want to be embroiled in a dispute and costly litigation. Carelessly thought out agreements are more likely to end up in litigation.
To order up to date Standard Form Alarm / Security / Fire and related Agreements, click here: www.alarmcontracts.com
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Kirschenbaum & Kirschenbaum PC
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