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Known Contingent Risks Can Be As Perilous As Unknown Risks

Business equity buy outs are obviously burdened by more potential risks than asset purchases. The keen eye of experienced counsel can help a client peer beneath the muddy surface water, anticipate and plan for the hidden liability dangers inherent in the equity transaction.

Yet, sometimes when the danger is not hidden at all but only contingent, the outcome can be as bad.

In a recent equity acquisition dispute, the court decision turned on the meaning of the word “threatened” added at the very last minute to the parties’ closing document.

On the eve of the closing the Pension Benefit Guaranty Corporation (PBGC) notified the seller of its concerns about the impending transfer of the firm’s pension plan to the buyer.

PBGC stated misgivings about the ability of the buyer to support the plan liabilities. Consequently, the parties were told PBGC was initiating an inquiry into the transfer.

But, the buyer decided to proceed with the transaction anyway. As a precaution and guard against the uncertainty of the inquiry outcome, buyer and seller entered a side agreement. It suspended the transfer of the pension plan until either a) the PBGC inquiry was closed in writing or b) for six months from the closing date as long as PBGC had not in the meantime “threatened” or taken administrative action.

Consequently, if PBGC neither took nor “threatened” action for six months, even if the inquiry were not over, the buyer had to take on the pension liabilities regardless of the adequacy of the plan assets.

The buyer’s risk was left to turn on the meaning of “threatened” because after six months the PBGC had not terminated its inquiry. In fact, during the six months, PBGC wrote to the seller “we are not convinced that this transfer satisfies the requirements for a de minimus spinoff (sale)”. The letter concluded that PBGC did not plan “to initiate legal action…at this time” but had not decided whether to pursue the matter through the Internal Revenue Service which with the Department of Labor has a role in pension plan regulation.

Naturally, the buyer contended that the letter from PBGC was a “threatened” administrative or legal action and declined to complete the purchase.

In the suit filed by the seller, the court ruled that PBGC did not utter a threat. Accordingly, the buyer was bound to assume the pension plan regardless of the risks. The court came to its decision saying that PBGC reserved the right to take action and merely expressed unhappiness with the transaction but that its position did not amount to a threat.

Awareness of the “fine lines” drawn by words is indispensable in lawyering.