Generally speaking, recoupment refers to a recovery of expenses. The term has several implications. In the context of investments made by a business in areas such as research and development, recoupment means a direct or indirect recovery of the investment through remunerative undertakings such as product sales or licensing agreements. Recoupment may also refer to the right of a respondent to petition the court of law to mitigate or dismiss a plaintiff or litigator’s claim due to the plaintiff’s violation of the same contract that the litigation is based on. In angel investing, recoupment refers to ways in which angel investors recover their investments from ‘stalled’ start-ups.
A Little More on What is Recoupment
Recoupment is the act of recovering past investments or losses by selling an asset or a part thereof so that the proceeds from the sale are sufficient to cover the investment or loss. The practice of recoupment is most widespread in the music industry, where record labels use it to claim advances that they paid to (especially debutant) artists.
Recoupment in Angel Investments
Investing in just one startup with potential for success can work wonders for an angel investor’s portfolio. Angel investors invest million of dollars in such ventures in hopes of gaining ownership equity or convertible debentures. These investors realize profits through positive exits on their investments.
However, not all exits are positive. Oftentimes, startups go out of business, resulting in negative exits. However, the worst case scenario is when ventures ‘stall’ after breaking even, i.e. they neither grow nor head toward a positive exit. A stall invariably forces investors to seek out ways to recover their investments, or, in other words, initiate the recoupment process. In most cases, angel investors are unable to recover the full value of their investments; nevertheless such efforts have often proved to be fruitful.
Recoupment can be enforced in either of the following ways:
- By selling shares back to the company.
- By selling shares to another shareholder.
- By running an auction with the consent of all investors.
- By allocating shares to all investors.
- By creating non-profit funds where investors can donate shares in return for a tax loss on the investment.
- By selling shares in stock exchanges or online platforms.
It should be noted here that it is not always a straightforward task to sell shares back to the startup company – often, startups do not possess sufficient capital to buy their shares back. Selling shares to another shareholder is an excellent method of recoupment provided the other shareholder has maintained a bullish position on the company or has an emotional stake in it. Distributing shares among investors is not a very desirable option and is usually treated as a last resort. Similarly, while it might be relatively easy to dispose of shares in secondary markets, investors are often forced to sell their shares at throwaway prices.
Recoupment in the Music Industry
Recoupement is rampant in the music industry where record labels habitually hand out payment advances to new artists. Once the artists’ music starts generating revenue, these companies start claiming their advance payments either directly from the artists or from sources related to them. Often, a cash-strapped debutant artist is left with no choice but to accept all the terms put forward by his or her record label.
References for Recoupment
Academic Research on Recoupment
Testing for predation: Is recoupment feasible, Elzinga, K. G., & Mills, D. E. (1989). Antitrust Bull., 34, 869. Predatory pricing is a form of pricing that aggressively undercuts competitors’ prices as a way to discipline or eliminate them. Most often, such a move forces a business’ rivals to either lapse or hand over price leadership to the business. A notable attribute of such predatory pricing initiatives is sustainable short-term losses on the part of the predator itself in order to inflict more severe, often unsustainable losses on the competitor.
Predatory pricing and recoupment, Leslie, C. R. (2013). Colum. L. Rev., 113, 1695. This paper scrutinizes the conditions that lead to the practice of recoupment and also studies its evolution. The author points out flaws in the assessment of recoupment in courts of law, mostly as a result of judges underestimating the complexities of market entry. He goes on to describe the various ways in which recoupment can occur. The paper contends that there are several instances where it becomes impossible to satisfy recoupment requirements owing to their structures.
The Role of Recoupment in Predatory Pricing Analyses, Hemphill, C. S. (2000). Stan. L. Rev., 53, 1581. This paper scrutinizes the primary objective of recoupment and argues that contrary to its common interpretation by courts, recoupment is a narrow structural analysis of a market. As such, it will be highly counterproductive to explain recoupment in terms of a predator’s behavior, in addition to structure. Moreover, it would be worthwhile to delve deeper into structure by analyzing its additional attributes.
The Doctrine of Recoupment in Federal Taxation, McConnell, D. N. (1941). Va. L. Rev., 28, 577. This article revisits the situations that led to the formulation of the doctrine of recoupment and the theories that constitute its foundation. It also details the applications of recoupment in law and equity and underlines its various shortcomings. The author then proceeds to explain the implications of recoupment in present day federal taxation.
Some Limits of Equitable Recoupment, Tax Mitigation, and Res Judicata: Reflections Prompted by Chertkof v. United States, Willis, S. J. (1984). Tax Law., 38, 625. This paper explores the limitations of the mitigation provisions of the Doctrine of Equitable Recoupment. The Doctrine was formulated to offer remedies for inconsistencies in taxes. However, an incorrect decision of the Fourth Circuit resulted in an improper expansion of the mitigation provisions. Inaction as well as gratuitous actions on the part of the parties also made recoupment unobtainable.
Equitable Recoupment: Revisiting an Old and Inconsistent Remedy, Watson, C. E. (1996). Fordham L. Rev., 65, 691. The federal government’s statute of limitations places restrictions on both the government as well as the taxpayer vis-à-vis asserting claims against the other after the expiration of a stipulated period of time. The formulation of such a statute stemmed from the need to maintain fairness as well as administrative efficiency. This article contends that recoupment comes across as a hugely ineffectual modern-day solution and instead, proposes development of the established elements and an approach that is more focused on the individual equities of each case.
Modern-Day Equitable Recoupment and the Two Tax Effect: Avoidance of the Statutes of Limitation in Federal Tax Controversies, Andrews, A. W. (1986). Ariz. L. Rev., 28, 595. Any dispute that involves federal income, gift, estate and excise taxes can be legally settled in three discrete ways. First, a taxpayer involved in a dispute can approach the United States Tax Court, which is a prepayment forum, to litigate the merits of the dispute. Besides, there are two post payment forums that the taxpayer can approach after paying the taxes in full – The United States Claims Court, or an equivalent federal district court. Post payment tribunals.
Can Governments Impose a New Tort Duty to Prevent External Risks-The No-Fault Theories behind Today’s High-Stakes Government Recoupment Suits, Schwartz, V. E., Goldberg, P., & Appel, C. E. (2009). Wake Forest L. Rev., 44, 923. This paper discusses the significant transformation of tort actions initiated by state and local government authorities against product manufacturers. The authors contend that government lawsuits target manufacturers whose products create external costs to be borne by others. Manufacturers of weapons are typically targeted since their products can be readily used to harm others, thus instigating litigation. There are also other products such as medication and toxic materials like lead paint that can result in litigation if misused or improperly handled.
Equitable Recoupment Revisited: The Scope Of The Doctrine In Federal Tax Cases After United States v. Dalm, Tierney, J. E. (1991). Ky. LJ, 80, 95. This paper examines the doctrine of equitable recoupment in the aftermath of the United States v. Dalm Supreme Court case of 1990. The aforementioned doctrine authorized the government to collect taxes and any taxpayer to collect refunds on taxes after the running of the statute of limitations for such collection in instances where the statute of limitations produces an inequitable outcome.
Markets linked by rising marginal costs: Implications for multimarket contact, recoupment, and retaliatory entry, Chen, Z., & Ross, T. W. (2007). Review of Industrial Organization, 31(1), 1-21. The authors scrutinize firms that service multiple locations from a single facility with escalating marginal costs. The objective of the study is to analyze the effect of such firms on product prices and well-being of multimarket contact. This model is also able to explain the phenomenon of recoupment in multimarket operations – i.e. utilizing higher prices in one market to pay for lower prices in another market.
Recoupment re-examined, Kohn, S. L. (1999). Am. Bankr. LJ, 73, 353. This paper scrutinizes the recoupment doctrine in bankruptcy and its legal implications. Recoupment enables a party to legally eschew restrictions and responsibilities applicable to other creditors involved in the bankruptcy estate. It also facilitates a favourable settlement of its claims. The Bankruptcy Code of the mid-1980s paved the way for several judicial applications of recoupment. However, towards the end of the 20th century, most courts started refusing to enforce recoupment.