On Oct. 13, 2023, a New York federal court held that sellers who breached representations made in an asset purchase agreement were liable to the buyer for damages calculated using an implied purchase price multiple from the time of the sale and an adjusted trailing 12-month EBITDA that took the sellers’ breaches into account.
In Taylor Precision Products, Inc. v. The Larimer Group, Inc., et al., Judge Andrew L. Carter Jr. of the U.S. District Court for the Southern District of New York determined that the sellers of Metrokane Inc. had breached certain provisions of a November 2013 asset purchase agreement regarding Metrokane’s relationships with key contractual counterparties and the impact on its projected revenues, resulting in the buyer paying an inflated purchase price for the company. After a finding of liability in February 2022, the court ordered further briefing on the appropriate measure of damages, and on Oct. 13, 2023, awarded $4,482,208 to the buyer to compensate it for the sellers’ breaches.
In determining the amount of the damages award, Judge Carter noted that under New York law, a plaintiff who had proven damages for breach of contract in the acquisition context is entitled to the “benefit of its bargain, measured as the difference between the value of the company it purchased as warranted by the Seller and its true value at the time of the transaction.” These damages are measured at the time of the breach, with the court explaining that inquiries into post-closing events and market conditions are improper and have no effect on the buyer’s general damages. Finally, once a buyer has established a breach entitling it to damages, it need only “show a stable foundation for a reasonable estimate of the damage incurred as a result of the breach.” This includes a “reasonable means of and basis for calculating damages,” but does not require perfection. After such a means is established, the burden shifts to the breaching party to showing any uncertainty in the damages calculation.
Here, the buyer calculated its damages using two components. The first calculated the diminution in value of the acquired company based on the permanent loss in sales that flowed from the sellers’ breach. The buyer’s expert demonstrated the impact of the decreased cash flows by adjusting the trailing 12-month EBITDA used at the time of the sale, and then applied the 7.55x purchase price multiple that was used in the acquisition to “reflect the ongoing nature” of the loss, opining that the buyer was damaged by approximately $4.5 million.
The second damages calculation offered by the buyer attempted to adjust the 7.55x purchase price multiple downward, and therefore reduce the purchase price that should have been used, to account for the impact of the sellers’ misrepresentations on the actual growth prospects of the company, estimating a changed growth rate from .05% to 1-2% and a corresponding reduction in the implied purchase price multiple.
In its holding, the court found that the buyer’s first component of damages successfully “isolated the effects of the breach” by adjusting the trailing 12-month EBITDA to account for the lost sales and applying the purchase price multiple that was derived from the original purchase price. The court held that this provided the necessary reasonable means of and basis for calculating damages because it was “directly tied to the information concealed” by the sellers and spoke to the value of the business on the day of the closing. Additionally, Judge Carter determined that, during the transaction negotiations, the buyer relied upon and “consistently calculated the adjusted EBITDA and identified an implied purchase price multiple in an effort to predict” the acquired company’s future value.
The buyer’s second damages component, however, was deemed too speculative to be a stable foundation of a reasonable estimate of the buyer’s loss, as required by New York law. Specifically, Judge Carter found that the variability of the impact of the misrepresentations on the estimated growth rate and revised purchase price multiple did not provide a reasonable means of and basis for calculating damages. As a result, the court awarded damages for only the first component of plaintiff’s calculations.
Judge Carter’s decision makes it clear that buyers using purchase agreements governed by New York law should make every attempt to identify the impact of any alleged misrepresentations on both the EBITDA used to determine the ultimate purchase price of the company and on the permanent loss of value to the acquired company. Additionally, establishing a record during negotiations of the use of and reliance on a purchase price multiple is necessary in order to apply such a multiple to future damages calculations in any litigation concerning the value of the business. Taking these steps will help ensure that damages calculations used in a post-acquisition dispute provide the reasonable basis that is required for a court to award the full amount of a buyer’s losses.