Explore the legal implications of fraud in M&A deals, particularly in cases where buyers agree to purchase assets “as is” without explicit assurances. Learn from a real case study and understand the importance of representations and warranties in protecting buyers’ interests.
M&A Stories
December 15, 2020
Introduction:
When acquiring a business, buyers often protect themselves from potential risks by requiring the seller to provide assurances and promises about the business’s condition. However, in some cases, buyers agree to an “as is” deal where the seller doesn’t make significant assurances.
Background:
In this situation, the buyer was interested in purchasing a business that designed systems for testing food products. The seller had developed testing systems for pathogens like Listeria and Salmonella. The product line included test kits, hardware for analysis, and software for running the tests.
The Deal:
The buyer, which partnered with food companies to improve food safety, wanted the seller’s product line. During negotiations, the seller provided positive information about the product line’s performance and certifications. Eventually, the buyer acquired the product line for $12 million through an “as is” deal using an asset purchase agreement. However, the seller did not include any explicit assurances or guarantees about the product line’s condition in the agreement.
The Problem:
After the deal was completed, the buyer discovered that the product line did not match the seller’s representations during negotiations. The Listeria test’s only commercial customer canceled their contract, the hardware couldn’t handle high-volume testing, the Salmonella test had detection issues, and it lacked certification. Furthermore, the hardware and Salmonella test were not ready for the market.
Legal Action:
Feeling misled, the buyer filed a fraud lawsuit against the seller in a Delaware Superior Court. The buyer’s complaint detailed each misrepresentation made by the seller, including when and where they were made, and identified the individuals present during these instances.
Legal Dispute:
The seller tried to dismiss the fraud claim, arguing that the buyer’s allegations were not sufficient to establish fraud. However, the court disagreed, stating that a jury should determine whether the seller had indeed made false representations and if those could be considered fraud.
This case is referred to as Phage Diagnostics, Inc. v. Corvium, Inc., C.A. No. N19C-07-200 MMJ [CCLD], Superior Court of Delaware, (Submitted: January 7, 2020. Decided: March 9, 2020)
Comment:
It’s worth noting that the buyer would have had a stronger legal position if the seller had included these representations and warranties in the asset purchase agreement. Additionally, the buyer’s fraud claim might not have been successful if (1) the seller clearly stated in the agreement that it was not making any additional assurances about the product line, and (2) the buyer explicitly stated that it wasn’t relying on any seller representations outside of the agreement.
By John McCauley: I help people manage M&A risks involving privately held companies.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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