Legal 123s with ByrdAdatto Tile

Legal 123s with ByrdAdatto (Too Good to Be True)

Bradford E. Adatto | 3.24.21

Some things are just too good to be true. Join us as we conclude season three with a final dumpster fire story where a client jumped into a rush deal without spotting the red flags. We discuss the value in slowing down and conducting due diligence before entering into a business arrangement.

 

Listen to the full episode using the player below, or by visiting one of the links below. Below is the episode’s transcript which has been edited for readability. If you have any questions or would like to learn more, email us at info@byrdadatto.com.

 

 

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Transcript

Intro: [00:00:00] Welcome to Legal 123s with ByrdAdatto. Legal issues simplified through real client stories and real world experiences. Creating simplicity in three, two, one.

 

Brad: Welcome back to another episode of Legal 123swith ByrdAdatto. I’m your host, Brad Adatto with my cohost Michael Byrd.

 

Michael: Thanks Brad. As a business and healthcare law firm, we have some amazing dumpster fire stories. A dumpster fire essentially means a mismanaged situation that results in utter disaster. This season, we have covered a ton of dumpster fires and it’s hard to believe this is our last episode of season three.

 

Brad: I know it has been an amazing, fun season of terrible, horrible, no good, very bad days for our clients in these stories. So in this last episode, Michael, this story is no different except there is a silver lining at the end.

 

Michael: What they liked the smell of char? [00:01:00]

 

Brad: Fair enough. Well, Michael, when I first started law school, which is, yes, back when the dinosaurs were roaming, I had my first break and I decided to go visit my girlfriend, now wife, in Fort worth. And I had dropped Mike off at work and I decided to go fill up her car at the gas station because it was low.

 

Michael: Let me guess, you got in a wreck on the way, because you were so busy patting yourself on the back.

 

Brad: For being such a nice guy? No, I did not. But at the gas station, this van pulled up next to me. So this was one of those older vans, a minivan, no side windows, looked like your typical work van, or maybe a killer van that they throw you in the back of. But anyway, I didn’t think too much about it. And these two gentlemen jumped out of the van and said, Hey man, Are you looking to buy some really good speakers and cheap? So they race the back of the van. They started opening the doors and they pull out these giant speakers and they’re telling me, Hey, we overbought, we got to [00:02:00] get rid of these and we can sell to you in cash for a major discount. And I was like, Hey, I don’t even live here, I’m just visiting and they kept trying all this stuff and finally, they just kind of drove off when I didn’t buy it.

 

Michael: I’m feeling a sense of deja vu here, Brad, keep going.

 

Brad: All right. Well actually it gets better. So fast forward about maybe six months later, I’m back in New Orleans in law school, and I’m walking to my truck at this grocery store parking lot in the middle of the day and a van, very similar to the one in Fort Worth, pulls up right next to me. Two guys jump out like, Hey man, we got these speakers and we got to sell it. And they gave me the almost exact same pitch again. And I kept saying, look, I understand. Thanks. Thanks. Thanks. So isn’t that crazy, I was in two different cities in a short timeframe and basically the exact same pitch from these two different guys.

 

Michael: Well, when we were doing our show prep for this Brad, you shared this with me and I shared what I’m about to share. And we laughed for 15 minutes afterwards [00:03:00] because of my stupidity. This happened to me as well, as you now know, except yes, I bought the speakers.

 

Brad: And when was this, were you were in Austin?

Michael: No, the summer after my freshman year of college. This would have been probably at the front end of this scam.

 

Brad: Oh yeah.

 

Michael: Because it was a few years before it happened to you. I had a summer job at a bank here in Dallas and I had money, which was an unusual circumstance, and I had gotten out of work and that same van, it sounds exactly the same, pulled up. The storyline is exactly as I remember it happening to me, except for $100 that I happen to have in my wallet. I purchased those speakers.

 

Brad: How those speakers work, Michael?

 

Michael: Well, what I was expecting was the nicest stereo equipment ever, because you know, [00:04:00] this is a long time ago. People won’t appreciate this, but you had actually stereo systems back then, the double cassette player and just added the CD player and those speakers were going to go great. And it didn’t sound that great.

 

Brad: And what did you do? But you kept them.

 

Michael: Well, of course I paid a hundred bucks, so I had crappy speakers for about six years.

 

Brad: Well done. Well, that actually leads us perfectly into today’s dumpster fire. So in this story, we had an entrepreneur who was starting off, he was looking at a lot of different ventures at the time, oil and gas or technology, pharmaceutical and medical products and drugs. So he was all over the place.

 

Michael: Yeah. It’s a lot of different industries that sounds like a serial entrepreneur who had his hands in a lot of different stuff.

 

Brad: He sure was. And he was the man. He was hardworking. Self-made, driven like nobody’s business. So for today, we’re going to call him Mr. Man. So Mr. [00:05:00] Man calls me up and tells me he needs help. He has this fast moving deal and it has to close this week.

 

Michael: Red flag.

 

Brad: Yeah we as attorneys get nervous when we hear deals need to close immediately with no background or deal. And that was happening here. Mr. Man learned about the service provider that had all these lucrative contracts and they’re going to miss paying some vendors. And this was going to cause a domino effect making the service company go under. The main owner of the service company was a charming gentleman in his late sixties. And he was real excited about the opportunity to work with Mr. Man. And throughout the week when I spoke with the main owner, we’ll just call him Freddy Benson.

 

Michael: Why Freddy Benson?

 

Brad: Well, Freddy Benson was a con man played by Steve Martin in the movie, Dirty Rotten Scoundrels.

 

Michael: Funny movie. And for all the other people who are 50 years old, I’m sure they’re laughing right now. You really got to [00:06:00] see a movie that’s not from the eighties. Brad.

 

Brad: Okay. Yes, but it’s a brilliant movie because for those who don’t see it, Freddy Benson is this con man and he’s very charming. So it kind reminded me down the road when I started to get to know this particular owner. And so that’s why I call him Freddy. So Freddy, has all these debts that were owed by the company. And so deal closes and Mr. Man says, all right, I’ll buy all these assets in the company and pay the debtors. Because based on the initial calculation, Mr. Mann was getting a great deal, as the assets actually far outweighed any of the debt.

 

Michael: Well this season’s about dumpster fires. So what went wrong?

 

Brad: All right. Well, after closing, strange occurrences start happening. The former CPA, and who also happened to be an owner of this, decided, you know what he was owed $20,000 for past services that he had provided that service company, and that CPA still had access to [00:07:00] the bank account that Mr. Man actually had just acquired. And he just took the money.

 

Michael: I don’t even know what to say. Usually I say red flag, but this is worse.

 

Brad: Yeah. The CPA is like, it was owed to me, so I took it and it was that simple. Mr. Man called the CPA and demanded that he returned the funds. He actually had us send the man a letter to return the funds, but then decided not to pursue it because ultimately the CPA ignored all the requests. But Mr. Man is like, you know what? At the end of the day, I still got a really good deal.

 

Michael: Well, that’s not that bad.

 

Brad: Yeah. It gets worse. So next it turns out the service company actually owed a bunch of back taxes that Freddy had forgotten to mention. And again, convinced Mr. Man to pay these taxes as it was going to impact the trade name, the service company.

 

Michael: Wait, I’m confused, Brad. So you had said that they bought all the assets, right?

 

Brad: That’s correct.

 

Michael: So this is somewhat of a word for the day, but an asset [00:08:00] sale is different from a stock sale. And legally speaking, we can talk a little more about that. When you buy an asset sale, you don’t assume the liabilities.

 

Brad: Yep. That’s correct. Mr. Man, as you said, didn’t need to pay it because, as you mentioned, it was an asset sale, so he did not assume those liabilities. But he had gotten a really good deal. So ultimately he paid it these taxes because it was a good deal. And even though he didn’t have the obligation to do it.

 

Michael: So that’s the extent of the dumpster fire?

 

Brad: No, there’s more. So, as I noted when we started this story, the main reason that a client bought these assets was because the service company had these lucrative contracts. So he was really excited about that. And so what we started to do is we start reviewing all these contracts and started seeing some problems.

 

Michael: Stop, so this deal was based on contracts. We’re in agreement there.

 

Brad: Yes, we are.

 

Michael: [00:09:00] Okay. You started reviewing these contracts after he acquired them?

 

Brad: Yeah. Remember this was a rush deal that we had to close within a week and Mr. Man had not even conducted any due diligence on this actual service company. Or all the contracts. In fact, at closing, we actually only had seen a few of the actual 50 or so contracts that he had acquired. But since my client was getting such a good deal, he didn’t really care that we had not seen all their agreements. What we learned is that the service company did have some very lucrative contracts. But the vast majority of these contracts were actually owned by subcontractors, meaning the entire reason why my client had bought these assets or contracts was to acquire the rights to these agreements. And after closing, he learns not only did he have to pay these other debts and obligations that he wasn’t prepared to do, but the actual main assets didn’t exist. Now Freddy claimed he had explained this [00:10:00] all to Mr. Man, but trust me this was the first time any of us knew this, in fact. Freddy had provided all these charts of the values of each contract on a nice, beautiful spreadsheet, but then it turned out that Freddy actually didn’t own the bulk of these contracts, but was just actually servicing them.

 

Michael: Wow. That’s a crazy story. I think it would have done Mr. Man some good to have bought those speakers that I bought years before and learned a lesson that way. We’re going to go into a commercial. On the other side, Brad and I will spend some additional time discussing what happened to Mr. Man, Freddy, and what should have happened to prevent this from becoming a dumpster fire.

 

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Brad: Welcome back to Legal 123s with ByrdAdatto. I’m your host Brad Adatto, and I’m still here with my cohost Michael Byrd. Michael, we just finished capping off how a client of ours bought a whole bunch of assets in a fire sale. Pun intended. And the deal, it had to get done immediately. And when I was telling the story, when you say close immediately, you just throw out red flag. Why do you think this was a red flag?

 

Michael: And I think anyone listening to this season will probably would have been able to call it as well. There’s been a predominant theme about too good to be true. Whenever it’s hurry up, we [00:12:00] gotta go, it’s got to close fast, it almost always turns out like this.

 

Brad: Yeah, I agree. And this is a situation that if Mr. Man had just slowed down, we could have spent some time and injury actually determining if it really was this great deal. We’ve talked about due diligence, Michael and in other episodes, but can you give some background as to what does it mean and what does it actually entail?

 

Michael: Well due diligence is kind of one of those lawyer words that puts normal humans to sleep when they hear it. But it’s just a fancy way of saying that you’re investigating the company or its assets and you’re trying to figure out are you actually getting what you think you’re getting when you make this purchase. And it should happen before entering into the agreement or a contract with the other party. The purpose is to make sure that you, as I said, that there’s an alignment [00:13:00] with what you think you’re buying and what you’re getting. And look, the reality is, most times it’s not like this where there’s a bad guy on the other end that you would have caught it and prevented a bunch of heartburn. A lot of times you just may think you’re getting something that is not quite that way. And it opens up an avenue for a conversation to help save the deal and restructure it when necessary, at least reset expectations.

 

Brad: Yeah. And a lot of times it comes down to the fact that you might trust a person look, Freddy, in this case was a very charming person, but you still should verify it. And hence the statement, you probably heard people say it a thousand times trust, but verify. And Michael, what are some of the documents people should review during a due diligence phase?

 

Michael: Well, let’s start with this deal and the obvious: the contracts.

 

Brad: That’s a good one. See, this is why your name’s in the wall.

 

Michael: Yeah. Don’t have to be a lawyer to realize that [00:14:00] if your entire amount of money you’re spending is to inherit some contracts, you might want to take a look at it, but there’s a wide range of documents when you’re doing one of these deals. You want to look at the corporate documents, their ownership documents, financials, their debt situation, their employment tax, intellectual property, and other agreements and commitments, and related party transactions. And really that’s kind of vanilla type information for any acquisition that you may be doing. And obviously, depending on exactly what you’re trying to acquire and what your goal is, you may hone in on the really important stuff.

 

Brad: Yeah. And that’s a great point is that, as you said, the due diligence is really like an investigation. The parties will learn a lot about that acquisition based on what they learn. And then that will impact, you kind of alluded to this, the purchase documents.

And so what we have seen over the [00:15:00] years, many different results from this, when the parties start moving forward, and they start figuring out what is it really worth? They say, you know what, everything’s good after my due diligence, I think we should move forward and want to close. Or two, they could say the value or the assets have decreased, and when we want to reduce the purchase price, or we want to add some indemnities. I know we’ve talked a lot about that in another episode, so I won’t go into what that means. And then finally, these liabilities are so unquantifiable I’m just going to either terminate this and walk away or, if this was a stock purchase agreement, I might move it over to an asset purchase agreement. Michael, you had discussed some of these details earlier in the episode. Maybe you can give some more insight to our audience as the difference between an asset purchase agreement and a stock purchase agreement.

 

Michael: So this deal was an asset purchase agreement. I’ll start with a stock purchase agreement and the very basic idea is that you may have the same amount of money that you’re going to [00:16:00] buy to “acquire this other company”. In a stock purchase, you’re literally buying the stock or the ownership interest of that owner and you’re kind of stepping into that owner’s shoes, and continuing to run the business that’s ongoing. I guess the pro would be, is that it’s a simpler transaction in some respects. There is continuity of the business because you’re just stepping into a running business, but there’s a long list of cons that make this ultimately a less than ideal way to go most of the time.

 

Brad: Yeah, and I want to add something. This is where people get a little confused. Sometimes when they do a stock purchase agreement, they say, I want to buy the stock and all the assets. And so when you’re trying to explain to them whatever the company owns, if you own that company, you own those exact same assets unless the parties agree otherwise.

 

Michael: So the problem is, is when you buy into [00:17:00] the stock or the company, you get whatever they have in terms of assets, you also get whatever they have in terms of liabilities. And a lot of times the seller doesn’t even know the extent of liabilities because it’s a company that oftentimes has been in business for years and they’ve just created risk and junk along the way that you’re stepping into. And so you want to oftentimes go with an asset purchase agreement because that kind of starts the history over, you know what you’re buying, you know what risks you’re assuming, and you’re starting fresh. Now, before I talk about the asset purchase a little more and talk about what that is, there are times where you have to go the stock purchase route for a number of reasons. If you’re in an industry that’s highly regulated and the business has special licenses that aren’t transferable, you may have to go that route just so you can continue to [00:18:00] operate that business. We obviously see it in healthcare with, example, surgery centers, but you see it in other industries as well. So onto the asset purchase agreement. This is what we were doing here, which is we are looking at, essentially, the balance sheet of the other companies, and we’re going to buy these assets and we may assume certain liabilities but we’re going to handpick those. But if we don’t hand pick them, we’re not taking them on. That’s why I was so surprised when Mr. Man was willing to write a check for these “back taxes”.

 

Brad: Yeah. He’s just being a good guy.

 

Michael: So what happened to Mr. Man and his awesome deal?

 

Brad: Well, as my dad always says, you get what you pay for. So in this case, we learned that Mr. Man was on the hook for more and more unknown expenses that Freddy, again, forgot to mention. And as we started modifying some of these contracts, [00:19:00] it was clear that Mr. Man’s new company actually own them. Freddy actually pushed back a lot and said, Oh, that’s not how the industry works. And kept pushing back, kept pushing back and slowly but surely without us knowing Freddy made sure that most of those contracts actually went to another company, basically reselling what he didn’t own.

 

Michael: This reminds me of our prior episode, Coke is Bad for Your Teeth, when the dentist was pulling something similar.

 

Brad: I think that’s the thing that people need to understand is you could have different titles. You could be a dentist or a doctor or a senior gentlemen, but ultimately there are conmen and thieves out there. And so in this case, Mr. Man learned a very valuable lesson of slowing down and conducting actual due diligence, or investigations, as you said earlier. And as you told me, this is a very expensive, or as you said, a very, very expensive lesson in the business world that he never forgot, and he never made this same mistake again about [00:20:00] rushing into a deal without conducting some adequate due diligence. Since then he’s actually started a fund and he’s probably worth about, let’s call it 30 million right now. So there’s our silver lining for Mr. Man that I promised at the beginning. Mr. Man was able to learn from his own dumpster fire story on the importance of when a deal is too good to be true, how to offset it with time and great due diligence. Michael, what additional recommendations do you have for our audience today?

 

Michael: I’ll just kind of tie it back to the whole stereo story. We were talking offline with our producer, Rob Griffin, who was on a prior episode. And he too had experienced the stereo scenario. And we were laughing because what was so compelling to me, as the sucker, the stereos were so big. And then remember this is back in the eighties, so it was pretty [00:21:00] impressive. And so it’s like the too good to be true, emotional pull of only a hundred dollars. And these things will be in my room blasting, this is going to be incredible. It’s the same kind of emotional reaction that people have in the business world. And Mr. Man, as we know, is very successful and he sees what a good deal is. He just learned a hard lesson of what appeared to be a good deal was really just someone pulling one over on him.

 

Brad: Absolutely. Well, Michael, that wraps season three of dumpster fires and we’ll have another announcement next Wednesday on the launch of season four.

 

Michael: Awesome.

 

Outro: Thanks again for joining us today. And remember, if you liked this episode, please subscribe, making sure to give us a five star rating and share with your friends. You can also sign up for the ByrdAdatto newsletter by going to our website at byrdadatto.com. ByrdAdatto is providing this podcast as a public service. This podcast [00:22:00] is for educational purposes. Only this podcast does not constitute legal advice, nor does it establish an attorney- client relationship. Reference to any specific product or entity does not constitute an endorsement or recommendation by ByrdAdatto. The views expressed by guests are their own and their appearance on the program does not imply an endorsement of them or any entity they represent. Please consult with an attorney on your legal issues.

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