Reviewing buy-sell agreements: traps for the unwary
NOTE: The following article is from the collection of articles in our Automobile Dealership Buy/Sell Newsletters. The newsletter deals with the complex area of buying and selling automobile dealerships. Some of the material may not be up to date because of changes in the law from the date shown at the end of the article. This article is not to be taken as legal, accounting, tax, or other advice. You should consult your own professionals for such advice and for any updating of the information provided.
A well-crafted Dealer Buy-Seller agreement may go along way to protecting parties in the event of litigation, but nothing can insulate parties when a deal goes bad. In this issue, we will look at certain issues which may arise in litigation between a buyer and seller.
Buy-Sell Contracts As the Central Focus.
When litigation arises between a buyer and seller over a buy-sell transaction, most, if not all, of the claims asserted by the plaintiff (whether the buyer or the seller) will arise from the buy-sell agreement and/or other agreements collateral to or a part of the buy-sell transaction. For this reason, the buy-sell contracts will necessarily be the central focus of any such lawsuit. Indeed, the buy-sell contracts are oftentimes referred to as being “the law of the case.” In other words, a determination in a court of law as to the rights and duties of the parties will be based in large part upon the language of the buy-sell contracts. A well-drafted contract-one that is thorough, clear, and precise in its terms-is therefore the best protection for a buyer or a seller in the event litigation arises.
Pursuit of an Early Settlement.
The filing of a lawsuit generally follows an earnest attempt by the parties to resolve their dispute without resort to litigation. Some may therefore believe that the filing of the lawsuit signals that prospects for settlement have been fully exhausted, and that the battle has been joined. This point of view may be short-sighted. Many cases involving disputes thought to be unresolvable end up being settled. The dealer and his attorney should always give serious consideration to pursuing settlement, even in the beginning stages of the lawsuit. A dealer should not be seduced into proceeding full throttle to trial just because he or his attorney believe that they have a strong case. The judge or jury may see things differently and disagree. It has been said that “a bad settlement is better than a good lawsuit.” Although this phrase may seem trite or hackneyed, there is a lot of truth in it. Reasonable settlement discussions should never be rejected out of hand, whether at the beginning of the lawsuit or on the eve of trial.
Initiation of the Lawsuit.
Lawsuits typically are filed because one of the parties to the transaction believes the other party has not performed or is not performing one or more of his obligations under the buy-sell contract. These failures to perform-or “defaults”-can occur prior to the close of escrow or after the close of escrow. The timing and nature of the claimed default will often determine the type of lawsuit which will be filed and the issues which will arise in connection therewith.
Perhaps the most common pre-closing default is the failure of the seller or the buyer to properly and timely proceed to close of escrow for a reason or reasons not permitted in the buy-sell contract. A default in the form of failing to properly and timely close escrow may be motivated by the buyer’s or seller’s discovery or realization that the transaction is not a good deal for them, or that a better deal may lie elsewhere. However, a failure to close escrow in violation of the buy-sell contract is not without penalty.
If the buyer is the party in default for failing to close escrow, the seller’s remedies may depend on whether the buy-sell contract has a liquidated damages clause providing for a stated amount of damages to be paid to and retained by seller in the event the buyer fails to close escrow. If there is a valid liquidated damages clause in the buy-sell contract, that will generally be the seller’s sole remedy. Accordingly, during the contract negotiation process, a seller should attempt to negotiate for a sufficiently large liquidated damages amount (generally in the form of the deposit tendered by the buyer) to protect himself from any loss resulting from a failure to close by the buyer, and also perhaps to give the buyer sufficient incentive to proceed to closing rather than walk away from the transaction. If the contract does not contain a liquidated damages clause, the seller will have to establish some actual loss in a lawsuit against the buyer for damages. This would generally take the form of selling to a replacement or other buyer (referred to in the law as “covering”), and then bringing suit against the buyer for the difference in the sale price, if any, plus expenses incurred in that connection. Attorneys fees may also be recovered against the buyer if the buy-sell contract has an attorneys fees clause.
If, on the other hand, it is the seller who failed to properly and timely proceed to close of escrow, the buyer’s preferred remedy would not be damages, but rather an order of the court forcing the seller to close escrow and execute the necessary documents. This remedy is referred to in the law as “specific performance.” Whether or not the buyer will be entitled to specific performance against the seller in this setting may again depend upon the language of the buy-sell contract. If the buy-sell contract contains a provision whereby the parties agree that if the seller is in default and does not close escrow, the buyer will be entitled as a matter of right to specific performance, then the buyer’s immediate remedy should be to file suit against the seller for an injunction to block any sale to replacement buyer, and to seek specific performance on the part of the seller to close the buyer’s deal. If, however, a specific performance clause is not in the buy-sell contract, the ability of the buyer to obtain specific performance in a lawsuit against the seller may be problematic, since the buyer will probably have to demonstrate that the nature and location of the business are unique and cannot be replaced with money damages. Accordingly, the buyer’s best protection is to insist on a specific performance clause when he is negotiating the buy-sell contract.
Post-closing defaults typically involve a failure of the seller or buyer to perform some continuing obligation. On the part of the buyer, a typical example would include the buyer’s failure or refusal to make a note payment or other payment due after closing of escrow. On the part of the seller, typical defaults might include the violation of a representation or warranty given by the seller in the buy-sell contract, or perhaps even violation of a covenant not to compete.
In the event of a post-closing default by the buyer in failing to make a required payment, the seller’s litigation remedy is clear. A seller would be well within his rights to file a lawsuit for money damages, and seek a pre-trial writ of attachment against the assets of the buyer. A writ of attachment is a provisional remedy whereby the seller can “attach” or place a lien on the assets of the buyer. It is a very powerful remedy and often leads to quick resolution of the lawsuit by way of the buyer’s paying the required amount. From the buyer’s perspective, a writ of attachment should be avoided if at all possible. Obviously, this is best done by making the required payment. However, if the buyer believes that there has been a deficient performance or a breach of a representation or warranty by the seller, which has caused damage to the buyer, the buyer may be able to use this as an offset or defense to a writ of attachment claim. For example, if the seller brought suit against the buyer for damages for failure to make a note payment, and the buyer had legitimate counterclaims against the seller for breaches of representations or warranties in an amount equal to or greater than the amount sought in the writ of attachment, the buyer may have a complete defense.
In the event of a seller’s default involving a breach of a representation or warranty, the buyer’s remedy is to bring a suit for recovery of all damages caused by the seller’s breach of the representation or warranty. To this extent, it is in the seller’s best interests to give representations and warranties sparingly in the buy-sell contract. Fewer representations and warranties given by the seller means there will be fewer chances for a possible default later on. On the other hand, it would be in the buyer’s interests to secure as many representations and warranties from the seller as reasonably possible in order to best protect his rights after closing.
This article is certainly not exhaustive of the types of disputes and issues which may lead to and arise from litigation in a buy-sell context. Rather, it illustrates some of the main types of issues which could arise if a buy-sell dispute leads to a lawsuit. Regardless of the nature of the dispute giving rise to the lawsuit, or the issues which thereafter arise in the lawsuit, it is undeniably the case that the terms of the buy-sell contract will be controlling as to most major issues. It certainly serves to underscore the thrust of the article in the Summer 2000 issue ofDealer Buy-Sell, viz., that great care and meticulous attention to detail should be given to all aspects of the buy-sell documentation process.
This article was written in 2000.