You just made one of the biggest purchases of your life: you bought a business. Congratulations! But after the dust settles from reaching this important milestone, you realize something’s off. Maybe the seller didn’t transfer all the assets you expected, or is claiming you cannot use the business’s name or logos. Maybe the business isn’t performing as well as the seller promised. Worse yet, the business is facing a lawsuit for something that happened before you even considered buying it.
Unfortunately, these situations are more common than you might think. So, what should you do when the business you bought isn’t what you thought it was?
Here’s a step-by-step guide to help you navigate this challenging situation.
1. Consult an Attorney
Your first move should be to speak with a Business Attorney. Generally, an attorney experienced in Mergers and Acquisitions or Business Litigation will be best equipped to help you understand the issues you face. Some examples of how an attorney may help include:
- Contract interpretation: The signed contract will be key to any negotiations with, or lawsuit against, the seller. Asset Purchase Agreements (APAs) are often complex and contain outdated language. An attorney is trained to understand these agreements and can help you navigate your rights and options under the APA.
- Legal strategy: A lawyer can help you develop a plan to address the issues with the business—whether that means negotiation, mediation, or litigation.
- Contract enforcement: In North Carolina and most other states, the contract is the best evidence of the parties’ agreement. An attorney will help you understand what legal options you have under the terms of the agreement and under the law, the potential outcomes of those options, and which options are in your and your business’s best interest.
2. Choice of Law and Forum Selection Clauses
Determine the law governing your agreement. Every state has different laws governing contracts, which may affect your rights. An attorney can review your APA to determine which state’s law applies and where to file suit. A well-drafted APA will include provisions that determine both, and because state contract laws vary, the implications of these provisions can significantly impact your legal strategy and the outcome of your case.
In addition to identifying which state’s law applies, many Asset Purchase Agreements also specify where any lawsuit must be filed. These “venue” or “forum selection” clauses can require disputes to be litigated in a particular state or county, even if neither party is located there. Venue provisions matter because they affect convenience, cost, and sometimes the practical leverage in a dispute. Being forced to litigate in a distant or unfamiliar forum can significantly increase expenses and complicate the enforcement of your rights. An attorney can review your agreement to determine whether a venue clause applies, whether it is enforceable, and how it impacts your overall strategy before any dispute is formally pursued.
3. Review the Representations and Warranties
Your APA likely includes Representations and Warranties: statements the seller made about the business’s condition, operations, financial health, and other aspects of the transaction, which you relied upon when closing the purchase. Those provisions have consequences for both parties, and your attorney will review the agreement to help you determine the truth and accuracy of them. For example, a common representation and warranty is that the written materials utilized in the closing are true. If one of these statements turned out to be false, you may have a claim for breach of contract. Another frequently litigated issue involving representations is one in which the seller represents that they have the proper title to the assets covered by the APA. If you discover that the assets you thought you were purchasing did not legally transfer, having an attorney review this portion may help you understand what exactly was encompassed by the deal and what your rights in the assets are.
After your attorney reviews your APA, they can help you determine whether the seller misrepresented the business and what remedies may be available. Other terms in the agreement, such as a Merger clause that limits your ability to rely on prior communications (like a Letter of Intent), also impact your rights under the agreement.
4. Look for a Material Adverse Change Clause
Many APAs include a Material Adverse Change clause, which acts as a condition precedent to the closing and allows the buyer to walk away or renegotiate the deal if the business suffers a significant negative event before closing, like key clients terminating their contracts with the business. If the seller took actions that materially damaged the business before closing, this clause may give you leverage for damages incurred after the deal closed.
5. Check for Indemnification Provisions
Indemnification clauses require the seller to cover certain losses or liabilities that arise after closing but stem from pre-closing events. These clauses often have strict notice and timing requirements that impact your ability to have the seller cover. Your attorney can help you comply with these requirements and pursue compensation if you’re entitled to it.
6. Determine If You Can Recover Attorneys’ Fees
Litigation is expensive, especially after you’ve just made a major investment by purchasing a business. Fortunately, asset purchase agreements can include terms that require the losing party to pay the prevailing party’s legal costs, which may mitigate the expense of enforcing your rights. Your attorney will examine your agreement for provisions of this kind and advise about your contractual and legal rights.
7. Check for Arbitration and Mediation Requirements
Similar to the Choice of Law and Venue clauses discussed above, many contracts contain Arbitration and Mediation clauses, which require alternative dispute resolution efforts prior to filing a lawsuit. These clauses can impact your rights and help you determine your obligations for seeking legal recourse.
8. Remember: Prevention Is the Best Strategy
If you are reading this before buying a business or you are planning to buy a business in the near future, remember that a well-drafted purchase agreement and a team of experienced professionals will be your best protection against future issues.
Work with an experienced Mergers and Acquisitions attorney from the beginning. They will direct you to other professionals, such as Accountants and Tax Professionals, who will help paint a full picture of the business you are buying. As the saying goes, an ounce of prevention is worth a pound of cure.
For those dealing with nonpayment or preparing for future transactions, the Business Disputes and Litigation team and the Mergers & Acquisitions team at Cranfill Sumner LLP are available to provide guidance suited to your needs. Please contact the authors for more information.
