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January 21, 2025 | By Patrick T. McCloskey
The definition of “Losses” is frequently negotiated in acquisition agreements with indemnification. While most buyers and sellers quarrel over the inclusion or exclusion of consequential damages, punitive damages and lost profits, damages based on diminution of value present a dangerous land mine for sellers.
In HH Medical, Inc. v. Walz,1 the Southern District of New York ruled that diminution of value damages were covered by indemnification under the applicable Purchase Agreement where such damages were not expressly excluded from the definition of “Losses.” Applying New York law, the court relied on Powers v. Stanley Black & Decker, Inc.2 to conclude “diminution of value instead is classified as a form of ‘general damages.’” Following Powers, the HH Medical court rejected the sellers’ argument that diminution of value damages constituted “lost profits” or “consequential damages,” which were expressly excluded from the “Losses” definition.
To make matters worse for the sellers, the HH Medical court accepted the buyers’ claim for diminution of value damages based upon a multiple of EBITDA. The sellers had cited Zayon Group LLC v. Latisys Holdings, LLC, a Delaware case,3 to argue that the buyer plaintiff failed to plead that diminution of value was “perpetual in nature” and the diminution claim should therefore be dismissed. The court distinguished HH Medical, pointing out that Zayon was a post-trial opinion with a full record that included expert testimony. The HH Medical court cited a different Delaware case, Swipe Acquisition Corp. v. Krauss,4 to support its ruling at the motion to dismiss stage:
Here too, based on the complaint’s allegations, it is plausible that a multiple of EBITDA could support a damages calculation. HH Medical seeks damages “in an amount equal to the difference between the inflated upfront $20 million purchase price and the actual value of the Company at the time of the Acquisition based on the true, properly accounted revenue and EBITDA figures.”
The complaint alleges that the parties “used a multiple of EBITDA . . . to evaluate and negotiate an appropriate enterprise value and purchase price for the Company.”
And to estimate the actual value of the [Company] at the time of the acquisition, HH Medical relied on the same valuation method used to determine the original purchase price, but it applied that method to the “the actual, properly accounted financial performance of the Company at the time of the Acquisition” [quoting the complaint]. At this stage, those allegations are sufficient.
Sellers can protect themselves from this predicament by expressly excluding “diminution of value” damages from the definition of “Losses” in the acquisition contract. It is important to note that in both HH Medical and Powers, consequential damages and lost profits were expressly excluded from the Losses definition. So, sellers who exclude these damage categories but are silent on diminution of value will be at risk of suffering the same fate as the sellers in HH Medical.
The other lesson that sellers can learn from HH Medical is that a court may be reluctant to dismiss a claim asserting diminution of value damages even if the diminution in EBITDA is not alleged to be perpetual. Sellers can address the risk of an EBITDA ripple effect (for all damages, not just diminution of value) by expressly excluding from the Losses definition any damage calculations based on a multiple of EBITDA or any other financial metric.
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As set forth on the disclaimer page of this website, this post is for general informational purposes only and does not constitute legal advice. No one should rely on the information in this blog post without seeking appropriate legal, accounting, tax or other appropriate advice from an attorney, accountant or other professional properly licensed in the applicable jurisdiction(s).
1 2024 WL 2093547 (SDNY 2024).
2 137 F. Supp. 3d 358 (SDNY 2015).
3 2018 WL 6177174 (Del. Ch. Nov. 26, 2018).
4 2020 WL 5015863 (Del. Ch. Aug. 25, 2020).
