Buyer of business loses misrepresentation claim against seller because claim was not based upon seller’s breach of contract

Madison, Wisconsin based Target, is a contract manufacturer of custom vitamin and trace mineral premixes and value-added branded feed ingredients for the animal feed market. Seller was Target’s president and Buyer its vice-president. Both shared in Targets’ day-to-day operations, and each owned 50% of Target’ stock.

Buyer purchased Seller’s Target stock in 2012 pursuant to a stock purchase agreement. After the closing, Buyer claimed that he discovered that, prior to the execution of the stock purchase agreement, Seller made a series of misrepresentations.

The misrepresentations were: a Seller misrepresentation that Target owned all the equipment used in the business; Seller’s failure to include accounts payable information for inventory that was purchased and received in September 2011 on the Target’s balance sheet; Seller’s failure to disclose that a major Target customer would be significantly reducing its business with Target; and Seller’s failure to disclose that another major Target customer had decided to switch suppliers in 2012.

After discovering these alleged misrepresentations, Buyer refused to make payments that were due Seller under Buyer and Seller’s agreements. Seller sued Buyer in a Wisconsin state court for breach of contract (failure to make post-closing payments required under the purchase documents). Buyer counterclaimed, accusing Seller of breach of fiduciary duty and fraudulent inducement (intentional misrepresentation).

Seller challenged the Buyer’s claims, asserting, among other arguments, that the economic loss doctrine required Buyer to base its misrepresentation claim only upon a breach by Seller of the stock purchase agreement. In this case, Seller pointed out that Buyer was not basing its misrepresentation claim upon a breach of contract claim but upon the tort claims of breach of fiduciary duty and fraudulent inducement (intentional misrepresentation). The tort claims Seller argued were barred by the economic loss doctrine.

The trial court agreed with Seller and effectively dismissed Buyer’s claims against Seller and Buyer appealed. The Wisconsin intermediate appellate court also agreed with Seller.

The appellate court held that under the economic loss doctrine Buyer could only sue Seller for Seller’s breach of the stock purchase agreement, which Buyer was not doing. This result furthers the policies, among others, of protecting Buyer and Seller’s freedom to allocate the economic risk associated with the Target business; and to encourage Buyer, the party best situated to assess the risk of economic loss, to assume the risk, allocate the risk through the stock purchase agreement, or insure against that risk.

Furthermore, the court noted that Buyer was able to protect himself from the risks of the Target business. The court noted that (1) Seller and Buyer were sophisticated businesspersons who negotiated agreements primarily geared to Seller selling his ownership interest in the Target business to Buyer; (2) Seller and Buyer were represented by counsel; (3) Buyer made affirmative representations in the stock purchase agreement expressly indicating that he had sufficient knowledge and experience to evaluate the risks associated with purchasing Seller’s stock; and Buyer affirmatively represented  in the stock purchase agreement that Buyer had been actively involved in the management and financial affairs of Target and that Buyer had sufficient knowledge and experience in making investments so as to be able to evaluate the risks and merits of his investment in Target.

This case is referred to as Reinke v. Jacobson, Appeal No. 2016AP2197, Court of Appeals of Wisconsin, District IV, (October 26, 2017).

Comment. There are times when a buyer can’t sue a seller of a business for breach of the purchase agreement. Perhaps it is because the agreement prohibited buyer from making a claim beyond a certain date, and the buyer’s claim was made after the purchase agreements deadline for making claims; or that the agreement caps the amount that the buyer can recover from seller as a breach of the agreement, and buyer’s claim exceeds this cap. Or perhaps the misrepresentation was not in the purchase agreement but was a something seller said in negotiations or was data room material.

To get around these problems buyers often seek recovery from seller for fraud or misrepresentation, and not based upon a breach of the purchase agreement. The law in this area permits such suits under certain circumstances. But a buyer’s claim often does not fall into one of the exceptions and must rely on a breach of the purchase agreement claim.

By John McCauley: I help people start, grow, buy and sell their businesses.

Email: jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

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Posted in economic loss doctrine, fraud in business sale, negligent misrepresentation, tort misrepresentation in M&A

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