By Kathryn Saunders, Senior Associate, Stevens & Bolton LLP
There are always risks for sellers when selling a business, but most business people would comfort themselves that the risks can be managed by seeking contractual protection in the sale documentation and making full disclosure of any issues to the buyer. The last thing most sellers would expect is for the sale agreement to turn out to offer no protection against a liability, and for the buyer to succeed in unwinding the sale. Nevertheless, that was the scenario in a recent case when a seller was held liable for fraudulent misrepresentation.
The facts were fairly straightforward. A listed company decided to seek a buyer for one of its under-performing, wholly-owned subsidiaries. An information memorandum was prepared, which described the products manufactured by the company and included figures for historic and projected customer sales. Updated figures were supplied at various presentations made to interested buyers and relied on as part of their due diligence.
During the negotiating process, a senior member of the seller’s board of directors was informed that the subsidiary’s second biggest customer was planning to terminate its supply contract. If true, this would impact on the figures supplied to the buyers for projected customer sales. Choosing to put a positive slant on this, the director treated it as a mere negotiating ploy by the customer designed to achieve a price reduction. He later claimed in evidence that he had assumed there was no serious intention to terminate. He said nothing to the prospective buyers. Other evidence showed, however, that the director had privately commented that the customer’s exit would make the subsidiary “unsaleable”.
The sale went ahead. The buyer was informed on the day following completion that a key customer was exiting the relationship. It claimed rescission of the sale contract on the grounds of fraudulent misrepresentation. Rescission is a legal remedy available for misrepresentation which essentially sets aside the contract and puts the parties into the position they would have been had the contract not been signed. No relevant warranties had been given in the sale agreement, so the buyer could not claim for breach of warranty.
A claim for fraudulent misrepresentation would be attractive to a buyer because it is not possible for sellers to exclude liability for fraud. To succeed in its claim, the buyer had to show that the director:
• Was aware the forecasts were being sent to potential buyers;
• Knew that the forecasts were false or misleading; and
• Chose not to reveal what he knew about the customer’s intention to terminate its relationship, with the intention that the forecasts should continue to be relied upon.
The court held that the seller was liable for fraudulent misrepresentation. The customer’s evidence as to communicating its intention to exit was preferred to that of the director, and the court found that the director was aware that the forecasts were being sent to potential buyers and kept silent, with the intention they would continue to be relied upon.
The buyer succeeded in its claim for rescission of the contract (although in the event it chose to keep the shares and received payment in compensation from the seller plus its legal costs). Rescission was only available because the buyer had acted quickly to alert the seller of the misrepresentation within a day of the sale. Even where rescission is not available, any damages awarded for fraudulent misrepresentation will not be limited by any negotiated exclusions of liability in the sale contract.
In share sales, criminal liability may also be an issue under section 397 of the Financial Services and Markets Act 2000 where there is dishonest concealment of material facts or statements or forecasts made which are known to be misleading, false or deceptive.
Sellers should know their team, and ensure that all members of the team are aware of the potential problems that could follow from keeping unwelcome information to themselves. Any indication that a member of the team may be withholding or supplying inaccurate information should be investigated, since it could undermine the seller’s warranties and might lead to an action for misrepresentation or possible criminal liability.
Kathryn Saunders is a Senior Associate in the Corporate Department at Stevens & Bolton LLP. Kathryn can be contacted on +44 (0)1483 401251 or by email at firstname.lastname@example.org.