Appellate Court Allows Breach of Contract and Fraud Litigation
12-27-2000
A recent Illinois Appellate Court decision has opened the possibility for further litigation following the issuance of a report by a third party accounting firm in a contested case between the buyer and sellers of a business. In Michael J. Lisle, Stephen N. Vedo, et al. v. Health Communication Services, Inc., Computerized Medical Communication, Inc. and CMC Technologies Corporation, Case No. 1-99-0931, the Appellate Court ruled that acceptance of the $2,155,633 earnout figure arrived at by the accounting firm Peed, Koross, Finkelstein and Crain (PKFC) did not preclude the plaintiffs from seeking further damages for fraud and breach of contract against the defendants.
"An earnout period is a common method of concluding the sale of a business," explained partner Eric Macey of Novack and Macey, counsel for the plaintiff-sellers. "The Appellate Court's decision allowing the plaintiffs to further pursue litigation even after PKFC's findings illustrates the importance of constructing a purchase agreement that clearly specifies the manner in which the buyer will conduct itself with regards to collecting revenues owed the business during the earnout period." Furthermore, Macey suggests that the decision will impact the future sale of other companies by raising the issue of whether or not the appointment of a neutral third party to participate in calculation of the earnout price is sufficient to protect the interest of the seller in matters where fraud is alleged.
The case began in August of 1993, when the plaintiffs agreed to sell their company to Health Communication Services, Inc. (HCS) for $5.9 million. In addition to the purchase price, an earnout provision allowed the plaintiffs to receive twelve times the amount of profits that exceeded a threshold of $541,666.67.
The purchase agreement, as amended in June of 1994, detailed the method by which disputes regarding the additional purchase price amount, or earnout provisions, would be resolved by a neutral accounting firm. When HCS tendered to the plaintiffs the figure of $2,155,633, the amount specified by PKFC, they refused to accept the tender as an accurate amount.
In resulting litigation, the defendants claimed PKFC's status as the duly authorized third party bound both sides, while the plaintiffs argued that PKFC's calculation deviated from the accounting methodology specified in the purchase agreement as amended.
The Circuit Court determined that the terms of the agreement were "completely clear" and PKFC's final calculation was meant to bind all parties. As a result, the plaintiffs' claims for breach of contract, breach of the covenant of good faith and fair dealing and fraud were dismissed with prejudice. The plaintiffs argued on appeal that HCS had purposely failed to pursue delinquent debts and issued undeserved credits to clients with the intention of depressing the earnout price. They alleged internal accounts of company officials actually verbalizing to staff their orchestrated plan to suppress revenues during the earnout period. The plaintiffs also cited the fact that collection staffers were reassigned to other areas of the company, leaving these former positions unstaffed.
The Appellate Court reversed the Circuit Court, reinstating the dismissed claims, holding that the neutral accounting firm's calculation of the earnout price did not bar these claims. As the Court stated:
"[T]he proceedings before PKFC did not provide plaintiffs with the proper forum in which to litigate their contract and tort claims. PKFC's engagement was strictly limited to the calculation of the APP, and did not extend to the resolution of any common-law claim that may have arisen between the parties. Given its limited engagement, PKFC could not have awarded the monetary relief sought by plaintiffs in their complaint."
Founded in 1984, Novack and Macey is a litigation firm that concentrates on complex commercial cases. The firm has successfully represented clients in a wide variety of business disputes, including matters involving banking, contracts, class actions, energy, RICO, securities, real estate, land use, partnerships and close corporations, antitrust, insurance coverage, environmental matters, business torts and employment-related issues. Novack and Macey attorneys have honed their skills in courtrooms, mediations and arbitrations nationwide. Clients include corporations, institutions, investment ventures, partnerships and individuals, as well as the United States Government.
For further information about Michael J. Lisle, Stephen N. Vedo, et al. v. Health Communication Services, Inc., Computerized Medical Communication, Inc. and CMC Technologies Corporation, please contact Eric Macey of Novack and Macey at (312) 419-6900.
For more information about Novack and Macey or to schedule an interview with Eric Macey, please contact Falk Associates, 847.675.2580.
"An earnout period is a common method of concluding the sale of a business," explained partner Eric Macey of Novack and Macey, counsel for the plaintiff-sellers. "The Appellate Court's decision allowing the plaintiffs to further pursue litigation even after PKFC's findings illustrates the importance of constructing a purchase agreement that clearly specifies the manner in which the buyer will conduct itself with regards to collecting revenues owed the business during the earnout period." Furthermore, Macey suggests that the decision will impact the future sale of other companies by raising the issue of whether or not the appointment of a neutral third party to participate in calculation of the earnout price is sufficient to protect the interest of the seller in matters where fraud is alleged.
The case began in August of 1993, when the plaintiffs agreed to sell their company to Health Communication Services, Inc. (HCS) for $5.9 million. In addition to the purchase price, an earnout provision allowed the plaintiffs to receive twelve times the amount of profits that exceeded a threshold of $541,666.67.
The purchase agreement, as amended in June of 1994, detailed the method by which disputes regarding the additional purchase price amount, or earnout provisions, would be resolved by a neutral accounting firm. When HCS tendered to the plaintiffs the figure of $2,155,633, the amount specified by PKFC, they refused to accept the tender as an accurate amount.
In resulting litigation, the defendants claimed PKFC's status as the duly authorized third party bound both sides, while the plaintiffs argued that PKFC's calculation deviated from the accounting methodology specified in the purchase agreement as amended.
The Circuit Court determined that the terms of the agreement were "completely clear" and PKFC's final calculation was meant to bind all parties. As a result, the plaintiffs' claims for breach of contract, breach of the covenant of good faith and fair dealing and fraud were dismissed with prejudice. The plaintiffs argued on appeal that HCS had purposely failed to pursue delinquent debts and issued undeserved credits to clients with the intention of depressing the earnout price. They alleged internal accounts of company officials actually verbalizing to staff their orchestrated plan to suppress revenues during the earnout period. The plaintiffs also cited the fact that collection staffers were reassigned to other areas of the company, leaving these former positions unstaffed.
The Appellate Court reversed the Circuit Court, reinstating the dismissed claims, holding that the neutral accounting firm's calculation of the earnout price did not bar these claims. As the Court stated:
"[T]he proceedings before PKFC did not provide plaintiffs with the proper forum in which to litigate their contract and tort claims. PKFC's engagement was strictly limited to the calculation of the APP, and did not extend to the resolution of any common-law claim that may have arisen between the parties. Given its limited engagement, PKFC could not have awarded the monetary relief sought by plaintiffs in their complaint."
Founded in 1984, Novack and Macey is a litigation firm that concentrates on complex commercial cases. The firm has successfully represented clients in a wide variety of business disputes, including matters involving banking, contracts, class actions, energy, RICO, securities, real estate, land use, partnerships and close corporations, antitrust, insurance coverage, environmental matters, business torts and employment-related issues. Novack and Macey attorneys have honed their skills in courtrooms, mediations and arbitrations nationwide. Clients include corporations, institutions, investment ventures, partnerships and individuals, as well as the United States Government.
For further information about Michael J. Lisle, Stephen N. Vedo, et al. v. Health Communication Services, Inc., Computerized Medical Communication, Inc. and CMC Technologies Corporation, please contact Eric Macey of Novack and Macey at (312) 419-6900.
For more information about Novack and Macey or to schedule an interview with Eric Macey, please contact Falk Associates, 847.675.2580.