Well drafted warranties offer purchasers protection by providing an avenue to seek recovery in the event that what is acquired turns out to be different than what it was represented to be by the seller.
This article looks at a case involving a share sale agreement and the outcome achieved when action was taken against the seller due to a breach of warranties offered in the share sale agreement to the purchaser.
Background
BCH (Buyers) agreed to purchase from Self Directed Super Funds Pty Ltd (Sellers) the Exelsuper group of companies, which operated a financial planning business.
On 11 March 2021, the parties entered into a Share Sale Agreement (Agreement), whereby the Buyer would acquire the shares to Exelsuper in two tranches.
BCH paid $2 million for the First Completion tranche of shares (~45%), with the balance ($7.36 million) due at Second Completion.
However, the relationship between the two parties deteriorated and the Second Completion never occurred.
The Buyers filed an oppression suit in 2021 in which an independent valuation revealed that the true value of the Exelsuper companies was far below what had been represented.
This finding triggered further litigation in 2022 for damages.
Claims and Legal Issues
The Buyers pleaded:
misleading or deceptive conduct as to the representations made prior to entering the Agreement by the Sellers; and
breach of contract as to a failure to disclose material information in warranties contained within the Agreement.
The Buyers claimed for damages based on a “no transaction” counterfactual – i.e., that they would not have entered into the transaction had they known the truth.
Court Findings and Reasoning
In respect of the misleading and deceptive conduct claim Stewart J found:
that the Sellers’ representation that recurring revenue was at least $2.361 million annually involved inflated figures and withheld information about several liabilities;
evidence submitted showed that Mr Gill, an accountant advising the companies, notified the Seller that the revenue figures were inflated, however, the Seller failed to proactively notify the buyer or correct these errors;
the Seller uploaded Mr Gill’s emails to a large data room without clearly disclosing material liabilities the Buyer;
The Court stated that that the large data room was “difficult” to navigate, with an index alone of 417 pages and sub-folder layouts sometimes 20 layers deep.
While the Court was satisfied that the Buyer relied on the false representations of the Seller to enter into the Agreement, the claim of misleading and deceptive conduct failed as the actual recurring revenue achieved came close to the represented amount, regardless of the revenue figures being inflated, at the time they were represented.
In respect of the breach of contract claim the Court found that:
1. The Agreement contained several warranties relating to the disclosure of material information, including:
1.1. all information contained within the Disclosure Documents (the data room) is true and complete and not misleading;
1.2. all information set out in the SSA is true, complete and not misleading; and,
1.3. the Seller has disclosed to the Buyer all information known to the Seller about the Business and the Company which would be material to a reasonable Buyer;.
2. the Buyers would have had a reasonable expectation of being put on notice about Mr Gill’s assessment that the recurring revenue projections were inflated.
3. Even though the underlying materials were technically available to the Buyer in the data room, in the context in which the parties found themselves and the context in which the events occurred, the mere fact that the documentation was available in a data room “without more” could not be considered to be an adequate “disclosure” in accordance with the Agreement.
4. This was “particularly so” as the Seller responded to direct due diligence inquiries by referring representations previously made without mentioning the withheld information on extant liability.
The Agreement also included a warranty to the effect that all forecasts and projections given by the Sellers to the Buyers about the business were to be based on reasonable assumptions.
The Court held that based on the assessment provided to the Seller by Mr Gill indicated that the revenue projections were inflated, without making these corrections known to the Buyer, the Seller had also breached this warranty.
Court Orders
The Court ordered judgment for the Buyer in an amount of $1,717,761 in damages plus interest from the judgement date and costs awarded against the Seller.
Key Takeaways
Businesses should be cautious when making revenue projections. Any statement made about recurring or future revenue must be well-founded, as overstating revenue – even implicitly or by omission – can result in liability.
Due Diligence is not a “free pass” to withhold or obscure key material information for a transaction.
Vendors cannot rely on a “data room disclosure” to shield themselves from liability if they fail to clearly disclose key material facts or correct misrepresentations. Businesses should be aware that merely placing documentation in a heavily populated data room may not amount to full disclosure.
Well draft warranties offer an avenue for recovery. In this case recovery from a failure to disclose material information.
For more information please contact Alicia Hill.
Alicia Hill
Principal
T: +61 3 9611 0180 | M: +61 484 313 865
E: ahill@sladen.com.au
