A seller in an M&A transaction will typically be obligated to indemnify the buyer for losses that the buyer incurs post-closing as a result of a breach of the seller’s representations and warranties in the purchase agreement. For example, if a seller represents that the target company has all required permits, but after closing the buyer discovers that the target is missing a key permit and incurs $50,000 in costs to obtain the key permit, then the buyer may be able to recover that $50,000 from the seller. But what if the buyer could also show that, because of the missing permit, the target company was actually worth $200,000 less than it would have been had the permit been in place at closing? Can the buyer recover for this diminution in the value of the target company?
Yes, according to a recent decision from the Southern District of New York, which found that “diminution in value” damages are available to purchasers in a business acquisition for a seller’s breach of its representations and warranties—even when the indemnity provisions in the purchase agreement exclude special damages. Although the court’s ruling was based on an interpretation of New York law, the case is instructive generally: sellers in M&A deals should specifically disclaim recovery for “diminution in value” damages within the indemnification provisions of a purchase agreement or otherwise be potentially liable for such damages.
In Powers v. Stanley Black & Decker, Inc., Powers brought suit against Stanley Black & Decker for unjustly objecting to the release of $4.2 million from an indemnity escrow, which was established in connection with Powers’ 2012 sale to Stanley Black & Decker. In mounting its defense, Stanley Black & Decker argued that the sellers had breached the representations and warranties in the purchase agreement by failing to disclose ongoing litigation related to anti-dumping duties owed by Powers to the Canadian government. As a result of this breach Stanley Black & Decker sought to be indemnified for (1) the actual amount of post-closing expenses incurred; (2) the costs associated with its mitigation efforts; and (3) the diminution in value of Powers’ worldwide business.
The indemnification provisions in the Powers purchase agreement specifically excluded “lost profits”, “consequential damages”, “punitive damages” and “opportunity costs”. Nevertheless, the court held that Stanley Black & Decker could recover diminution in value damages and that such damages—in the context of an M&A deal—do not constitute lost profits or consequential damages, but instead, are considered “general damages”. The court ruled that a buyer in an M&A deal purchases the business, and in part, values that business based on the representations and warranties made by the seller. If those representations and warranties turn out to be false, and as a result the business is worth less than the buyer paid—then the buyer is entitled to damages in the amount of the difference in order to be made whole.
The American Bar Association’s biennial 2015 Private Target Mergers & Acquisitions Deal Points Study, a survey of published transactions that closed in 2014 involving a private seller and a public buyer, revealed that only 17% of transactions included an express exclusion of damages based on diminution in value. The overwhelming majority of deals, 72%, were silent as to the exclusion or inclusion damages based on diminution in value
The Powers case underscores the need for sellers to parse the indemnification language in purchase agreements carefully. Where possible, sellers are strongly advised to exclude, specifically, “diminution in value” damages from the types of damages recoverable by the buyer.
Luis F. Ruiz