An excellent contract analysis by Glenn D. West in, “The inequity method of accounting: California family learns about private-equity hardball while selling supermarket chain,” reported news that sent shockwaves through the private equity deal community. The article chronicled a contentious dispute between the former owners of Save Mart, a prominent California supermarket chain, and Kingswood Capital Management, a Los Angeles-based private equity firm. The arbitration award detailed in the article, which required Save Mart's sellers to pay the buyer approximately $70 million post-closing, has left many industry insiders stunned. This case highlights the critical importance of precise contract language and comprehensive due diligence in mergers and acquisitions (M&A).

Transaction Overview

Save Mart Supermarkets, LLC, operated over 200 stores in California and Nevada and held a significant equity interest (approximately 52%) in Super Store Industries (SSI), a wholesale grocery distributor. SSI’s $109 million debt was not reflected on Save Mart’s balance sheet due to its treatment as an unconsolidated subsidiary under the equity investment method. This meant Save Mart only showed its net investment in SSI, rather than the gross debt.

In March 2022, Kingswood Capital formed SM Buyer LLC to acquire Save Mart. The deal, structured as a “cash-free, debt-free” transaction, had a base purchase price of $245M. Save Mart's owners withdrew $205M in cash before closing, leaving a balance of about $40 million to be paid at closing. The Equity Purchase Agreement (EPA) included a purchase price adjustment mechanism to account for various financial metrics post-closing.

The Hidden Debt and Contractual Language

The crux of the dispute lay in the definition of "Closing Date Indebtedness" in the EPA, which broadly included any debt for which Save Mart was responsible, directly or indirectly. This definition encompassed SSI’s $109M debt, which the sellers did not initially include in their calculation. However, Kingswood included this debt in their post-closing statement, resulting in a significant adjustment.

Key contractual provisions were scrutinized during arbitration. The original definition of "Purchase Price" in the EPA accounted for various adjustments, including "Closing Date Indebtedness," defined as:

"The aggregate amount of all Indebtedness of the Group Companies as of the Adjustment Time."

The broad definition of "Indebtedness" includes:

“(i) the outstanding principal amount of and accrued or unpaid interest of (A) indebtedness of such Person or its Subsidiaries for borrowed money and (B) indebtedness evidenced by notes, debentures, bonds or other similar instruments, and (xi) all liabilities and obligations of other Persons for the payment of which such Person or its Subsidiaries is responsible or liable, directly or indirectly, as obligor, guarantor or surety.”

Arbitration and Legal Rulings

The arbitration ruling, issued by a former Delaware Chancery Court judge, favored Kingswood based on the literal contractual language, despite acknowledging that extrinsic evidence suggested the SSI debt was not intended to be included. The arbitrator’s strict interpretation was consistent with Delaware's contractarian approach, which emphasizes adherence to the contract’s explicit terms.

In confirming the arbitration award, Vice Chancellor J. Travis Laster of the Delaware Court of Chancery highlighted the narrow scope of judicial review for arbitration awards. He noted that while he might have ruled differently, he was bound to uphold the arbitrator’s decision due to the clear and unambiguous contract terms.

Lessons Learned

This case underscores the critical importance of clear and comprehensive contract drafting. The broad definition of "Closing Date Indebtedness" and the inclusion of SSI’s debt, despite its accounting treatment, highlights the potential for significant financial implications from seemingly minor details. It also serves as a cautionary tale about the complexities of M&A transactions and the need for meticulous attention to contractual terms and potential liabilities.

Conclusion

The $70M surprise faced by Save Mart’s sellers illustrates the complexities and risks inherent in M&A transactions. It underscores the necessity for precise contract language, thorough due diligence, and a deep understanding of all potential liabilities. For private equity firms and business owners alike, this case serves as a potent reminder that in the world of high-stakes deal-making, every detail matters.