This blog explores the legal ramifications of fraud in M&A transactions, specifically focusing on a case where a seller’s fraudulent misrepresentations led to significant financial damages that were deemed non-dischargeable in bankruptcy. It highlights the importance of accurate disclosures during business sales, the role of financial misrepresentation, and the consequences for sellers who attempt to evade liability through bankruptcy. The blog offers insights into protecting buyers from fraudulent actions and understanding the limits of bankruptcy protection in asset transactions.
M&A Stories
October 14, 2024
When a seller or its owner commits fraud in a transaction, the resulting damages can be significant—and in some cases, non-dischargeable in bankruptcy.
In this case, the owner of a commercial cleaning company sold the business’s assets to a buyer for $1.2 million in August 2016. The seller’s owner had grown the company from $1.8 million in sales in 2013 to $3.8 million by 2015, with pre-tax profits increasing from $43,000 to $605,000 over the same period. The buyer financed most of the purchase with a $1 million SBA loan.
After the sale, the buyer discovered that the seller’s owner had committed fraud. The financial statements from January through July 2016 overstated gross income by over $400,000 and inflated accounts receivable by nearly $150,000. The seller also failed to disclose key facts, including a $125,000 line of credit taken out weeks before the sale to address cash flow issues, a list of jobs that was more speculative than accurate, employee raises that occurred just before closing, and that many of the company’s employees were not OSHA trained. Worse, the company had employed undocumented workers and had been fined for failing to verify their legal status.
When the buyer sought to unwind the deal, the seller’s owner transferred the sale proceeds out of the company and obstructed the buyer’s access to financial information. The seller’s owner eventually filed for bankruptcy.
The buyer brought a claim against the seller’s owner in bankruptcy court, seeking to prevent the discharge of any damages awarded for fraud. The seller’s owner admitted that the financial statements were inaccurate and acknowledged the undisclosed facts but argued that he was unaware of these issues. He claimed to be a “simple janitor” and blamed the company’s bookkeeper and office manager for the discrepancies.
The court did not accept this defense. It found that the seller’s owner, far from being uninformed, was an experienced businessman who was actively involved in the company’s operations. The court awarded the buyer $764,000 in fraud damages and ruled that the debt could not be discharged in bankruptcy.
This case underscores the serious consequences of fraud in business sales, where misrepresentations can lead to substantial financial liabilities—even in bankruptcy.
Case Reference: In Re Dannie, Case Nos. BK23-80623, AP23-8025 , United States Bankruptcy Court, D. Nebraska, (October 1, 2024).
Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.
Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law.
By John McCauley: I write about recenegal problems of buyers and sellers of small businesses.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Podcasts https://www.buzzsprout.com/2142689/12339043
Check out my books: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles and Selling Assets of a Small Business: Problems Taken From Recent Legal Battles
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