Buying a company has many legal risks for a buyer. One of the most important tools to manage the risks of buying a business is to conduct a thorough due diligence investigation of the company.
This case involved a $2 million dollar acquisition of a California kitchen remodeling business. The seller limited the buyer’s access to his company’s documents, ostensibly to avoid employees leaving the company if they learned a sale was likely.
Thus, the buyer was limited to reviewing company documents during a meeting at the seller’s attorney’s office that were in a binder. The buyer was not permitted to keep the binder.
The buyer sued the seller after the closing in a California federal district court. The buyer claimed that many of Seller’s stock purchase agreement representations were false, and that the seller’s company had significant undisclosed debts, paid many of its employees outside of formal payroll to avoid pay deductions, and lacked basic financial records.
The seller argued that the buyer should have been aware of any payroll or accounting irregularities at the seller’s company as a result of the due diligence process, and specifically as a result of Bank of the West and American Express account statements that the seller claimed were included in the due diligence binder that the buyer reviewed in the seller’s attorney’s office.
The buyer apparently did not think that the due diligence binder included this information and asked the seller to produce the binders during the discovery phase of the litigation. The seller said that he did not have them and did not know where they were.
The buyer asked the court to sanction the seller for not producing the binder by issuing an order excluding the seller from introducing any evidence of the documents that the seller claimed were made available for the buyer to review in the due diligence binder. The buyer argued that this information, especially the Bank of the West and American Express bank records procured later were not a substitute for the actual collection of documents that the buyer reviewed in the due diligence binder before closing the deal.
The court refused prohibit the seller from offering this information in evidence because the seller had no duty to preserve the binder.
This case is referred to as Cardinal v. Lupo., Case No. 18-cv-00272-JCS, United States District Court, N.D. California (September 17, 2019) https://scholar.google.com/scholar_case?case=5341473029730680698&q=%22stock+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017
In 20/20 hindsight, the buyer would have insisted upon keeping the due diligence binders or at a minimum add a provision in the stock purchase agreement requiring the seller to preserve the due diligence binder for a reasonable period of time after the closing.
By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million
Telephone: 714 273-6291
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