A company facing a reduction of $5 million in sales from its #1 customer, sued a former employee/director for breach of a trade restraint. The company and its shareholders took legal advice whether they should litigate or negotiate a $4 million share sale with the former employee’s new employer (who was a large competitor). The company was advised it had reasonable prospects of enforcing its trade restraint and receiving damages as well as an interim and final injunction. Litigation was commenced and was subsequently settled for $1.0 million damages, recouped costs of $300,000 and a voluntary trade restraint that its former employee/competitive employer would not deal with #1 customer for 12 months.
When informed about the settlement, #1 customer advised it wanted the company and the competitor to compete on price and service – or otherwise lose its business. To keep part of #1 customer’s business (and assuming that it could use its $1.3 million cash to regrow its sales revenue), the Company agreed.
When tax time arrived, the Company was told its tax bill on the $1.0 million damages and the recouped $300K legal fees was $390K (assume 30% tax). Sensing commercial advantage, the competitor aggressively reduced its pricing for #1 Customer. The Company’s gross margin fell by 40% when it price matched. The opportunity to rebuild its sales never arrived. Faced with a $390K unexpected tax bill, substantial staff redundancies and stock write-offs, the company’s shareholders fire-sold their shares to the competitor for $500,000.
THE HEARTACHE. Having successfully settled the litigation, the failure by the company to understand its market, its #1 Customer and its tax obligations on the settlement resulted in the shareholders losing the opportunity of selling their shares for $4 million as opposed to $500K.