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Case Study January 11, 2021

Transaction liability claims case study: Not so tasty transaction

A newly acquired restaurant chain failed to disclose lease agreements on unfinished builds, as well as alleged violations of labour laws

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When an a newly acquired restaurant chain failed to disclose lease agreements on unfinished builds, as well as alleged violations of labour laws, they put their new owner up for thousands of dollars in potential reparations and renovations.

The insured, an international private equity fund with a diverse portfolio of assets, recently closed the acquisition of a chain of fast-causal restaurants across the country for $300m. Soon after the acquisition had been finalised, the private equity fund discovered the restaurant seller had mistakenly omitted details about various elements of the business and the transaction. They uncovered undisclosed lease agreements which would have resulted in the firm having to spend substantial amounts of money in renovating the properties to make them suitable for operation. They also uncovered a handful of alleged violations of labour laws which would have meant the firm would have been liable for any fines or penalties imposed on the acquired business.

Undisclosed leases

Nine lease agreements were not disclosed by the seller. The insured accepted four of the undisclosed leases, claiming that the previous restaurant owner was planning to either construct new restaurants or incur maintenance and refurbishment costs on each of the undisclosed sites.

The insured claimed $4.4m and alleged that the seller had breached the signing and closing property representations in the acquisition agreement, due to its failure to disclose all the leased property. 

By working closely with CFC’s transaction liability claims team, the matter was investigated, settled and loss agreed within six months from the date CFC received notification.

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Labour law claim

The second notification related to alleged violations of labour laws whereby a number of 16 and 17 year olds had exceeded the hourly restrictions on certain weeks during their shifts at the restaurants. The Attorney General Office (AGO) started an investigation and subsequently fined the restaurant chain $409k for these failings. These violations had been occurring prior to signing, but the private equity firm had agreed to the acquisition.

The private equity firm was also aware of the ongoing investigation by the AGO from the close of the acquisition, but did not notify CFC of this matter for a further 18 months, as none of these allegations had been disclosed by the seller prior to signing or closing of the acquisition. 

As the violations had occurred both before and after the closing of the acquisition, the ultimate liability was shared between the firm, the sellers and CFC, which represented the period up until the insured became aware of such breaches (via the AGO investigation), and the continuation of the violations by the firm following closing.

The private equity firm had taken out a transaction liability insurance policy with CFC. The policy was tailored to the specifics of a restaurant acquisition and the
possible issues they could run into, including labor claims. Following agreement between the firm and CFC as to the amount of the loss resulting from the OAG violations, it was agreed by CFC’s in-house claims team that the remaining deductible of the policy would be eroded as full and final settlement of this matter.
The claim was investigated, settled and loss agreed within six months from receiving notification.

If the private equity firm had not taken out comprehensive transaction liability insurance they would not have had access to CFC’s award-winning in-house claims
team and would have had to spend considerable time and money in pursuing the claim against the seller in court. This may or may not have succeeded, which would have left the firm with extensive legal costs, as well as the costs involved in both renovating/accepting the undisclosed properties, as well as the penalty imposed by the AGO.

To find out more about CFC’s transaction liability insurance, please contact the team.

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