Explore a cautionary tale in M&A where a seller alleged fraud due to buyer’s financial misrepresentations. Understand the legal nuances and lessons learned.
M&A Stories
December 17, 2018
In this M&A legal blog post, we discuss a case where a seller alleged fraud regarding the buyer’s financial misrepresentations. Let’s break it down in a more concise and reader-friendly manner, keeping it professional:
In 2014, a seller provided litigation support and legal staffing services, while the buyer was in the same business. They signed an asset purchase agreement, with the buyer acquiring the seller’s assets for $9.9 million in cash and $2 million in preferred equity.
The seller could cash out the preferred equity after three years, provided it didn’t breach the parent company’s lender arrangement. They also pledged this equity to secure indemnification obligations.
However, after the deal, the seller claimed that the buyer had given inflated revenue and earnings forecasts, which were crucial in determining the equity’s value. The seller sued the buyer for fraud, among other claims, but the court dismissed the fraud claim.
The court stated that a fraud claim required several elements, including material misrepresentation, knowledge of its falseness, intent to induce reliance, justifiable reliance, and resulting damages. The court found that the buyer hadn’t made a material misrepresentation.
The court also ruled that it was unreasonable for the seller to rely on the buyer’s financial forecasts, as the seller didn’t develop its own forecasts. Furthermore, the asset purchase agreement made it clear that the seller couldn’t rely on the buyer’s representations unless explicitly stated in the agreement.
There was no fraud claim based on the buyer’s claims of having a substantial war chest and a line of credit. The seller didn’t take steps to confirm this information.
The lesson here is that sellers receiving buyer equity as part of the purchase price should be cautious. When selling a company and receiving buyer equity, sellers need to scrutinize the buyer’s representations and warranties, making them as comprehensive as the buyer’s regarding the business being sold.
Case Reference:
This case is referred to OmniVere, LLC v. Friedman, Case No. Docket No. 154544/2016, Motion Seq. No. 005, Supreme Court, New York County, (December 6, 2018).
By John McCauley: I help people start, grow, buy and sell their businesses.
Email: jmccauley@mk-law.com
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Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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