Sale of Business Law Blog

What Are You Selling When You Are Paid for the “Good Will” of Your Business?

Recently, the United States Court of Appeals for the Second Circuit held that a seller of the “good will” of a business is not barred from answering the factual inquiries made by the former client as long as the seller’s responses are within the scope of the information sought by the former client. Bessmer Trust Co v. Branin, 16 N.Y. 3d 549 (2011).

Branin worked as an investment portfolio manager at Brundage, Story & Rose, LLC (Brundage). While working at Brundage, Branin became the favorite of one of Brundage’s clients, the Palmer family. Eventually, Brundage sold its assets, including client accounts and related good will, to Bessemer. For a while, Branin continued to work for Bessemer. Eventually he resigned from Bressemer to join Stein Roe. Before leaving Bessemer, Branin prepared a list of his clients to help Bessemer transition the accounts to other investment advisors at the firm. Branin did not notify his clients about his decision to join Stein Roe. Thus, he did not actively solicit any of his former clients. In spite of this, several of Branin’s clients decided to transfer their accounts to Stein Roe. The Palmers were among them.

Before transferring their accounts to Stein Roe, the Palmers had a separate meeting with each of the firms to discuss how the firms would handle their accounts.  Branin participated in the meeting between Stein Roe and the Palmers, but only as a passive participant. Finally, after meeting with both the firms, the Palmers decided to transfer their accounts to Stein Roe. Based on this, Bressemer, Branin’s former employer brought an action for breach of good will against Branin. The United States District Court for the Southern District of New York found that “Branin ‘improperly induced the Palmer account to leave Bessemer and that this inducement in fact caused the Palmer account to leave Bessemer and join Stein Roe’ in violation of New York law.” Id at 555.

Branin appealed and the Court of Appeals barely provided anything useful other than the basic principles regarding solicitation of former clients. The Court not only acknowledged the absence of a specific rule to determine whether a seller of “good will” has engaged in improper solicitation of his former clients, but also declined to create one.  The Court held that “while a seller may not contact his former clients directly, he may, ‘in response to inquiries’ made on a former client's own initiative, answer factual questions. Furthermore, under the circumstances where a client exercising due diligence requests further information, a seller may assist his new employer in the ‘active development . . . [of] a plan’ to respond to that client's inquiries. Should that plan result in a meeting with a client, a seller's ‘largely passive’ role at such meeting does not constitute improper solicitation in violation of the ‘implied covenant.’ As such, a seller or his new employer may then accept the trade of a former client.” Id at 560.

The lesson of this case is to tread very carefully when one could be accused of backtracking on the sale of business good will.

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When is it Appropriate to Use an Indemnification Provision in Selling a Business?

Most people selling their business are unaware (at lease at the outset) that the contract of sale normally includes some sort of indemnification language. There are many variations, but in the typical case, this means that the seller agrees to hold the buyer harmless from claims of third parties relating to what the seller did or did not do when they owned the business. Likewise, the buyer holds the seller harmless from claims of third parties for what the buyer does or does not do after the sale concludes. 

Obviously, there are many legitimate variations to this approach. For example, if the seller is going to continue as a consultant or even employee to the business, the indemnification may need to take into account that he should continue to have some sort of indemnification obligation. Likewise, one might decide to define the indemnification obligation as applying to no more than a fixed upper amount or limit it to a certain period of time.

In the extreme case, a buyer or seller might want to take the position that there should be no indemnification provision at all. This includes situations in which the business is being sold for a relatively small sum that is less than the business is actually worth. In such a case, the seller may insist that it is being sold “as is” and “with all flaws” the same way as distressed real estate. In other words, the price figures in the risk inherent in having no indemnification clause.  

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Three Questions to Ask When Buying a Business’ Intellectual Property

One of the most frequently overlooked aspects of the sale of a business is the transfer of intellectual property. This includes, among other things, copyrights, trademarks, patents and non-disclosure rights. There are some basic questions that a purchaser of a business should ask in this regard. Set forth below is a list of three such questions and some interesting answers that may not be obvious:

1. If the business has a logo, can it be transferred?

Answer: Maybe not. If the logo infringes on the intellectual property rights of a third party, even if it can be transferred, it should not. Essentially, the purchaser is buying a lawsuit. Likewise, the logo might not be available to be sold, such as if the seller uses it under a license agreement which does not allow for assignment to a new purchaser. There are many other examples, but the point is that just because the seller is using the logo does not mean it can or should be sold.

     2.  If the buyer purchases the business, does that mean he automatically owns the business’ website?

Answer:  One might think so. After all, of what use is the business’ website to the seller after he sells the business? However, the answer is no. The reason resides on two levels. First, the sale agreement and ultimate bill of sale must have sufficient language in it to transfer the intellectual property rights to the website. Second, even it does, the seller must have the right to sell that intellectual property. For example, what if a website developer later claims that it did not give the seller the right to the website’s underlying source code? In such event, how does the buyer hire someone else to make renovations to the website that would involve using that source code? So, does the buyer really own it?

     3.  If the Seller entered into a non-disclosure agreement with a third party concerning the seller’s trade secrets, is that agreement enforceable by someone that buys the business?

Answer:  This is another maybe. The legal analysis is on two levels. First, did the sale agreement and ultimate bill of sale assign contract rights in the non-disclosure agreement? Second, did the non-disclosure agreement allow for that assignment of the business’ rights?

In sum, when purchasing a business the buyer must be acutely aware that the intellectual property it thinks it is purchasing, may not actually be transferred. It is critical that the underlying legal documents be scrutinized to ensure that this does not become a problem later on.

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One Cannot Fraudulently Transfer Business Assets to a Related Business to Escape a Creditor

On July 19, 2010, the Federal District Court for the Southern District of New York decided a case regarding the issue of successor liability and fraudulent conveyance in which a debtor transferred its assets to a related business and left a creditor without any return on its investment or any repayment on its loan.  The Court in Silverman Partners LP v. The Verox Group et al., 2010 WL 2899438 (S.D.N.Y.) held that the plaintiff had alleged sufficient facts to show that it could be inferred that Verox Technologies was a continuation of Verox Group, and in addition that there may have been a fraudulent conveyance.  Id. at 5-6.  The Court cited plaintiff’s allegations as:

After Verox Group ceased doing business, Verox Technologies continued to operate under the direction of Verox Group's Managing Members, with Verox Group's EPA registrations, and all of Verox Group's assets.  Verox Technologies also hired two of Verox Group's independent sales representatives and conducted business with some of Verox Group's former customers.  While Verox Technologies was registered in Nevada and Verox Group in Delaware, both have their principal places of business in New Hampshire and that they occupy the same physical location.  Verox Group is now a shell company with no cash or other assets and that there was, essentially, a de facto merger between Verox Group and Verox Technologies.

 

Id.at 2.

 

 Verox Group transferred all of its assets to Verox Technologies sometime after June 21, 2007, that the Managing Members devised a scheme where they created Verox Technologies to avoid the debts and obligations which Verox Group owed to Plaintiff, and that the transfer was made by Verox Group and received by Verox Technologies with actual intent to hinder, delay and/or defraud Plaintiff as a shareholder and creditor.

 

 Id. at 6.

The Court held that based upon the pleadings, plaintiff alleged sufficient facts such that it could be inferred that the buyer de facto merged with a seller. Since that would mean that the buyer was a mere continuation of the seller, and the transactions were undertaken to defraud creditors, the Court denied Verox Technologies’ motion to dismiss plaintiff’s claims.  Id. at 5-6.

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If You Guaranty a Contract For Your Company, Can You Become Liable For Its Breach?

On July 23, 2010, the Superior Court of Connecticut was presented with the following question: if someone signs a contract on behalf of a corporation, under what conditions will that person be individually liable as a guarantor if the corporation defaults? The Court determined that the answer had to do with whether or not the provision of the contract providing for the guaranty was clear and unambiguous.

    In this case, the provision read as follows: “the signer of this agreement does by his execution personally and individually undertake and assume the full performance hereof including payments of amounts due hereunder.”  The Court in Yellow Book Sales & Distribution Company, Inc. v. Valle, –A.2d— 2010, WL 3326845 (Conn. Super.) held that this provision was too ambiguous to be enforced.

    Connecticut General Statutes § 52-550(a)(2), the codification of the statute of frauds in Connecticut, provides in relevant part that “[n]o civil action may be maintained in the following cases unless the agreement, or a memorandum of the agreement, is made in writing and signed by the party, or the agent of the party, to be charged.”  Id. at 2.  Applying that law, the Court reasoned: 

 

"It is well established that an agent, by making a contract only on behalf of a competent disclosed or partially disclosed principal whom he has power so to bind, does not thereby become liable for its nonperformance.  If a contract is made with a known agent acting within the scope of his authority for a disclosed principal, the contract is that of the principal alone, unless credit has been given expressly and exclusively to the agent, and it appears that it was clearly his intention to assume the obligation as a personal liability and that he has been informed that credit has been extended to him alone.  When these two principles are read together, the law presumes that where a writing contains the signature of a duly authorized agent, the party to be charged is the principal and not the agent because the agent individually is not a party to the agreement.  Instead, the principal is the party to the agreement.  Otherwise, every agreement signed by an agent on behalf of his principal would be admissible as a promise by the agent individually to answer for the debt of his principal."

Id. at 4.

"In the present case, when looking at the document as a whole, the agreement is ambiguous as to whether the defendant was individually a party thereto.  On the one hand, [the provision] attempts to make the Signer a party to the agreement by requiring the Signer to undertake a personal obligation to secure the debts of the principal.  Nevertheless, the rest of the agreement excludes the Signer entirely and specifically provides that the agreement is between Yellow Book and Moving America.  In other words, all of its provisions except for [the specific] paragraph relate exclusively to the duties and obligations of Moving America and Yellow Book.  The parties' signature also indicates that the agreement is between Yellow Book and Moving America because it is signed by the defendant in his capacity as President of Moving America."

Id. at 5.

The Court held that because the writing is ambiguous as to whether the defendant individually was a party to the agreement, it did not furnish a complete agreement as to its terms.  Id. at 8.  Further, it did not satisfy the statute of frauds as a matter of law.  Accordingly, the Court granted the defendant's motion for summary judgment and denied plaintiff’s. 

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New York Court Upholds Cause of Action for Indemnification Under Asset Purchase Agreement

On July 19, 2010, the Federal District Court for the Southern District of New York decided a case in which it interpreted an asset purchase agreement (“APA”). The Court in Koch Industries, Inc. v. Aktiengesellschaft, -- F.Supp.2d --, 2010 WL 2927441 (S.D.N.Y.) held that “when defendants sold plaintiffs a polyester manufacturing business in 1998, defendants fraudulently concealed that the business was violating antitrust laws.” Under the indemnification provision of the APA, , the plaintiffs would be entitled to damages for the period prior to the closing.  The reason was that the terms of the APA clearly applied to that situation,

“[u]nder the APA, defendants agreed to indemnify plaintiffs for losses associated with the conduct of the polyester business prior to the Closing. Specifically, Section 2.4 of the APA requires Hoechst to pay all “Retained Liabilities” and provides that the “Buyer [Kosa] shall not assume or become liable for any obligations, liabilities or indebtedness of any member of the Seller Group, and ... the members of the Seller Group shall retain all of their respective liabilities, other than the Assumed Liabilities, whether or not relating to the ownership or operation of the Polyester Business.” Section 17.2(a)(i) of the APA requires Hoechst “to defend, indemnify and hold harmless the Buyer Indemnified Parties from and against ... [a]ny and all Losses resulting from or in connection with, directly or indirectly, the failure of Seller and its Affiliates to pay, perform and discharge when due all Retained Liabilities.”

Id. at 1-2.

    The Court held that “Plaintiffs have satisfied their burden at summary judgment to show that defendants are liable, under the indemnification provision of the APA, for a portion of the Defense Costs that constitutes “Retained Liabilities.” The calculation of proper damages on the indemnity claim remains an issue for trial.” Id. at 23.

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Lack of Bad Faith as a Basis for a Court Not to Award Attorneys Fees To a Minority Shareholder who Sues to Obtain Compensation for her Shares

Earlier this year, a State Court in Delaware determined the value of a minority shareholder’s shares which was in dispute. The unpublished opinion, In re Sunbelt Beverage Corp. Shareholder Litigation, 2010 WL 26539 (Del.Ch. Jan 05, 2010) (No. Civ. A. 16089-CC), reconsideration den., In re Sunbelt Beverage Corp. S'holder Litig., 2010 WL 692400 (Del.Ch. Feb 15, 2010) (NO. CIV.A. 16089-CC) was brought by Jane Goldring, a “former minority shareholder in [a] beverage corporation, who had been forced out of [the]corporation as result of [a] cash-out merger of a former corporation into beverage corporation. [The shareholder] filed suit against individual members of [the] beverage corporation's board of directors, alleging breach of fiduciary duty, and seeking [rescission] or, the alternative, an appraisal of fair value of her shares as of merger date.” Id. at 1.

    The Court analyzed the different ways a minority shareholder’s interest can be evaluated for purposes of determining the value the shareholder should be paid, whether in the form of a sales price or damages. The Court rejected a number of approaches, but ultimately used a discounted cash flow calculation to arrive at the compensation the minority shareholder should receive.

    Importantly, the Court then granted her an additional award of court costs, such as expert witness fees, but refused to provide her with reimbursement of her attorneys fees. The reason the Court refused to award attorneys fees was based on a lack of bad faith on the part of the defendants. The Court reasoned that although the defendants’ “WPG Formula” for valuation of the shares was rejected by the Court, it was not submitted in bad faith.

I agree with defendants' analysis on the issue of shifting attorney fees: “to constitute bad faith [and thus warrant shifting of attorney fees contrary to the American Rule], the defendants' action must rise to a high level of egregiousness.” Here, I cannot find defendants' actions to be of the egregious, vexatious, or bad-faith sort that have merited the shifting of attorney fees in earlier cases… I believe defendants' reliance on the transactions priced at the WPG Formula was sufficiently reasoned to preclude a finding that there was no legal issue in this case upon which reasonable parties could differ. That is, parties could and did reasonably differ on the legal import of the WPG Formula. The WPG Formula ultimately may have had no weight in my valuation analysis and may have played an unduly large role in guiding defendants' other valuations of Sunbelt stock at the time of the 1997 Merger, but it did present me with a legitimate legal question and a potentially legitimate valuation metric for Sunbelt. I therefore do not find defendants to have conducted themselves with the necessary egregiousness or vexatiousness to warrant shifting attorneys' fees.

Id. at 9

 

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What Value Should be Assigned to Shares Under a Buy Sell Agreement in Which the Value is Not Listed in the Contract?

A buy sell agreement is an effective tool to create a predictable value for shares in a closed (non-public) corporation. However, what happens if the buy sell provision refers to an exhibit that is not attached and the formula simply cannot be applied as intended in the agreement? The New York Appellate Division dealt with that issue in Sullivan v. Troser Management, Inc.,    N.Y.S.2d    , 2010 WL 2636019 (N.Y.A.D. 4 Dept.), 2010 N.Y. Slip Op. 05894

    That case was decided on July 2, 2010. “[T]he dispute … relate[d] to the value of an 18% stock interest in a ski resort under the parties' “buy-sell” agreement (“agreement”).” The Court held that “the purchase price provision of the agreement [was] unenforceable, and the value of plaintiff's stock should therefore be determined pursuant to the formula set forth in the unrelated New York case, Lewis v. Vladeck, Elias, Vladeck, Zimny & Engelhard(57 N.Y.2d 975), i.e., based on a percentage interest in defendant's assets.” Id at 1.

    The Court concluded that “[t]he ‘Purchase Price’ provision of the agreement expressly states that the price of the shares of stock shall be ‘an amount agreed upon annually by the Stockholders as set forth on the attached Schedule A.’ It is undisputed that no Schedule A exist[ed]. That provision further state[d] that, ‘[i]n the event that no annual value is established, the value shall be the last agreed upon value except that if no such agreed upon value is established for a period of two years, the value shall be the last agreed upon value increased or decreased by reference to an increase or decrease in book value of [defendant] from the date of the last agreed upon value to the date of death or disability” of the stockholder seeking to sell his or her shares.’ Id at 1

    The problem was that “the stockholders … never agreed upon a value of the stock, and … the purchase price of [the] shares therefore [could] not be ascertained in accordance with the terms of the agreement… Indeed, there is no evidence in the record that plaintiff has ever agreed upon a value of the stock.  Id at 2

    Therefore, the method of valuation was based solely on a percentage interest (in this case, 18%) in the assets of the ski resort.

 

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Free Seminar Provides Legal and Financial Insights in Preparing for the Sale of a Business

Strategizing the Exit Strategy is being jointly provided as a free seminar to business owners and their advisors by the Nissenbaum Law Group, LLC and B2B CFO, Inc.®. The ninety minute presentation will provide an overview on the key issues involved in selling a business from two different seller-perspectives of the sale: that of legal counsel and that of an outside chief financial officer. The discussion will focus on what a business owner can do to prepare himself and his business for an eventual sale, including:

• Setting a sale price and what a business owner can do to enhance his sale price;
• What a business owner can do now to prepare to sell his business a few years from now;
• Describing various exit options that may be available to an owner and designing a strategy to meet those goals;
• Preparing the business’s financial records in preparation for a sale;
• Organizing corporate books and records to prepare for legal due diligence; and
• Preparing contracts and intangible assets to enhance your purchase price.

The Strategizing the Exit Strategyseminar is scheduled for January 7, 2009 at 7.00 PM and January 15, 2009 at 10.00 AM at the Nissenbaum Law Group's Union, New Jersey offices. Space is limited and being offered on a first come, first serve basis. To register contact Laura Magedoff, Esq. at 908.686.8000 or by email at ljm@gdnlaw.com.

For more information about the seminar, please see www.iaosolutions.net.

New Jersey Appellate Division Confirms that the Consumer Fraud Act Does Not Apply to the Sale of Business

Caselaw: New Jersey: The New Jersey Appellate Division recently evaluated a claim arising from allegations of fraud in connection with the sale of business and associated real estate. In 539 Absecon Boulevard, LLC. v. Shan Enterprises, et. al., 2009 WL 774474, the defendants had sold the plaintiff a motel business; the real estate upon which the motel resided; and adjacent property. The plaintiff, the purchaser in the transaction, claimed that the seller had falsified its income figures and therefore, defrauded the purchaser in the sale transaction. Among its other claims, the plaintiff-purchaser sued the seller for fraud and a violation of the New Jersey Consumer Fraud Act (“CFA”).

 

The CFA is a broad, remedial statute aimed at protecting New Jersey consumers from a seller’s wrongdoing in connection with the sale of merchandise and other services. However, while the CFA specifically applies to sales of real estate, it has previously been construed not to apply to sales of businesses. Nevertheless, the lower Court made the determination that the CFA applied to this sale transaction. Its analysis was based upon its conclusion that “a distinction could be made when, as here, the transaction involved both the sale of a business and the sale of real estate.” The Court viewed the transaction as primarily being real estate driven with the business operating thereon to simply be an “improvement” attached to the property. The Court awarded treble damages and attorney’s fees to the plaintiff accordingly.

 

However, the Appellate Division reversed the decision, specifically finding that the CFA was not aimed at transactions involving the sale of a business. The Appellate Division specifically noted that the New Jersey legislature determined that it wanted to extend the CFA’s reach to real estate, but had specifically not addressed the sale of business. The Appellate Division concluded that had the legislature wanted such a transaction addressed, they would have included it within the statutory language.

 

Moreover, the Appellate Division noted that the real estate was not the main draw of the transaction but instead was “incidental to the motel business” that had been sold. Accordingly, it dismissed the lower Court’s rationale for applying the CFA. The Appellate Division specifically noted that the CFA is aimed at sellers of merchandise that are offered to the public as a whole, and that a one-time business sale transaction was of a nature not covered by the Act.

 

Accordingly, the Appellate Division specifically concluded that the CFA does not apply to the sale of a business, even if that sale includes a sale of real estate. The New Jersey Supreme Court denied certification in June, so the ruling stands.

 

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