In 2015, Buyer, an Israeli pharma company purchased Target, a Mexican pharmaceutical company, from Sellers, and the intellectual property used by Target from a Sellers affiliate. The total sale price came to $2.3 Billion.
After the closing, Buyer claimed that Sellers lied about and concealed violations of the law which keep Target from selling its products postclosing, and which undermined the value of Target and its intellectual property. Specifically, Buyer learned that Target had engaged in a long-term scheme to sell defective and illegal products and hide these facts from Mexican regulators.
Buyer sued Sellers in a Manhattan state court for among other claims, fraud for Sellers’ misrepresentations in the representations and warranties in the agreements and for providing fraudulent due diligence materials. Buyer in its complaint described the alleged fraud in detail as described below.
Mexican pharmaceuticals must be submitted to the Mexican FDA, similar to the Food and Drug Administration in the United States. Once approved, the product sold must match the approved formulation. Target avoided the Mexican FDA review by creating a fraudulent fast track program, in which it submitted falsified applications for formulations it had not yet developed or tested. It would then sell products under those approved formulations, even if the product was different. Target kept two sets of records of its products, which it called double paperwork, so it would have one set of papers and computer records which would show compliance with the regulations, and one reflecting Target’s true activities. Target also lied to the Mexican FDA about its suppliers and what tests it had performed to determine the shelf life of the products.
Sellers were senior officers of Target, and aware of Target’s actions, including the fast track program and the double paperwork. Sellers lied to Buyer during the acquisition and presented Buyer with the false documents. Sellers were also aware of the falsity of the representation in the acquisition agreement that Target was operating materially in compliance with applicable laws. Buyer relied on those false representations, and the double paperwork prevented Buyer from discovering the fraud.
A week after the transaction closed, Buyer received an anonymous e-mail alerting it to the falsified product registrations, double paperwork, and other issues. Buyer then alerted the Mexican FDA, which inspected the Target plant and ordered Buyer to stop production of 44 different products. Mexican FDA subsequently shut the plant down entirely. It is unknown if and when Target will be able to sell its products again, and Buyer suffered reputational damage, in addition to losing the benefit of its bargain in purchasing Target.
Sellers asked the court to throw out the fraud claims which primarily revolved around Sellers furnishing Buyer during due diligence the false set of Target papers and computer records which showed compliance with the Mexico FDA regulations. Sellers argued that Buyer agreed in the acquisition documents to only rely upon the representations and warranties of Sellers that were contained in the acquisition documents; and not on data room material supplied during Buyer’s due diligence.
The court agreed with Sellers. First the court noted that Buyer was a sophisticated buyer of businesses and performed extensive due diligence on Target before entering into a major transaction, including a site visit and employee interviews. If Buyer had wanted Sellers to represent and warrant the accuracy of the Mexico FDA compliance material, then it could have negotiated for this representation and warranty to be included in the acquisition documents. But Buyer did not.
Buyer responded to this point by arguing that Buyer should be excused under applicable New York law from requiring Sellers to represent and warrant that the Mexico FDA material furnished Buyer was accurate because it was not reasonable for Buyer to suspect that Sellers were lying. The court disagreed saying that if the Mexico FDA compliance materials were not matters peculiarly within Target’s knowledge, and Buyer had the means available to Buyer of knowing, by the exercise of ordinary intelligence, the accuracy of the Mexico FDA material, then Buyer must make use of those means, or Buyer will not be heard to complain that Buyer was induced by Sellers to enter into the transaction by misrepresentations.
Buyer countered by saying that Buyer did not ask Seller to make a representation and warranty that the Mexico FDA materials were accurate because it had no knowledge of the inaccuracy of the Mexico FDA material and no way of discovering that it was inaccurate in the exercise of reasonable diligence. The court agreed that Buyer might be excused if due diligence would have been futile, but the court found that Buyer provided no reason that it could not have discovered the truth.
Specifically, the court noted that Buyer had access to Target’s personnel, facility, and products. The court concluded that Buyer did not allege any reason why Buyer could not have established that the products did not match the formulations.
This case is referred to Representaciones E Investigaciones Medicas, SA De CV v. Abdala, Docket No. 655112/2016, Mot. Seq. Nos. 006, 007 and 009, Supreme Court, New York County, (Filed August 2, 2017). https://scholar.google.com/scholar_case?case=1061886467576930045&q=%22stock+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2017
Comment. Buyer’s loss of the fraud claim was a major blow to Sellers. The remaining Buyer claim was for breach of acquisition agreement representations and warranties such as Sellers’s representation and warranty that it was in compliance with all applicable laws.
However, prevailing on that claim would be at most a Pyric victory in that Buyer had alleged a massive loss on the $2.3 billion purchase price Buyer paid for Target. Damages for a Buyer breach of contract claim win would be limited by the acquisition documents to a cap of $45 million.
In 20/20 hindsight, this case demonstrates that a buyer should borrow from Ronald Reagan’s slogan about doing arms limitation deals with the former Soviets: trust but verify. In this case a deeper dive into the Mexico FDA compliance area may have resulted in no deal; or a deal at a deeply discounted price.
By John McCauley: I help people start, grow, buy and sell their businesses.
Telephone: 714 273-6291
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