UK: Seller Beware!

In the ordinary course, the maxim of buyer beware applies, with buyers being well advised to undertake sufficient due diligence to satisfy themselves of the value and quality of what they are buying.

The recent decision of MAN -v- Freightliner has turned this maxim, at least in part, on its head.

MAN successfully claimed against Freightliner for losses that it sustained after purchasing ERF Holdings plc ("ERF"). Freightliner was held liable for fraudulent misrepresentations made by an individual involved in the sale of ERF during negotiations despite being unaware of the fact that the representations made were fraudulent and despite the fact that the individual concerned was not one of Freightliner’s employees.

MAN acquired ERF for £100m, the price being based on accounts showing a small profit and net assets of £25m. The share purchase agreement included a standard representation and warranty that the relevant accounts "fairly represented" the financial position of ERF.

Post completion, MAN discovered that ERF’s financial controller had fraudulently manipulated the accounts and that ERF was making losses with net liabilities of £75m.

MAN sought damages on the basis that the financial controller was part of the seller’s team on the transaction and heavily involved in the negotiations leading up to the sale and the due diligence investigations.

The court held that although the financial controller was involved on Freightliner’s behalf in the negotiations, he was neither a director nor an employee of Freightliner and there was no evidence that he was involved in the decision to commit Freightliner to the sale purchase agreement or in deciding the price or terms on which ERF should be sold.

His dishonest knowledge could not be attributed to the seller in those circumstances.

The court did, however, hold that the financial controller acted as Freightliner’s agent when he misrepresented ERF’s financial position to MAN during negotiation meetings rendering Freightliner vicariously liable for the financial controller’s fraud.

This case highlights a number of important lessons for both sellers and buyers:-

• Sellers should exercise caution in their selection of deal teams. Sellers may be vicariously liable for the statements of their employees and advisers made during negotiations or due diligence and may also find themselves liable for statements made by target company employees during negotiations.
• Buyers should ensure that important due diligence statements form part of the eventual purchase agreement.
• Both buyers and sellers should be aware of the limits and problems associated with general disclosures. Matters deemed to be disclosed do not necessarily include inferences to be drawn from items inspected. From a buyer’s perspective, matters deemed to be disclosed should be properly considered during due diligence and great care should be taken with deemed disclosures of matters which should be detected from a "reasonable investigation".
• Parties to a transaction need to give careful consideration to the disclosure exercise and to the choice of their team for a transaction to avoid effectively losing the benefit of the protections set out in the carefully drafted purchase agreement.

The material contained in this e-update is of the nature of general comment only and does not give advice on any particular matter. Recipients should not act on the basis of the information in this e-update without taking appropriate professional advice upon their own particular circumstances.

© MacRoberts 2006