Officer of company selling assets can be liable to buyer in tort for material misrepresentations and omissions even though not a party or guarantor to the asset purchase agreement

Today I want to talk about James. He was the officer of a company (“Seller”) which owned and operated an Anytime Fitness center franchise in Nicholasville (a small city outside of Lexington, Kentucky).

In September of 2016, Robert, owner and manager of a company we will call Buyer, became interested in acquiring Seller’s assets and commenced due diligence.

As part of the due diligence, Robert asked James about the competition in the area. James knew “that a new, competing gym, Workout Anytime, was set to open in Nicholasville in close geographic proximity to … (Seller) …  (In fact, James spoke to one of Seller’s employee’s) … about his concerns about competition from Workout Anytime.”

Nevertheless, in responding to Robert’s competition question, James “never mentioned the planned Workout Anytime facility.”

Right before the December 2016 closing, James learned that Cal Laboratory, one of Seller’s largest customers, was not renewing its corporate membership with Seller for 2017. James did not tell Robert about losing this customer.

Buyer purchased the assets of Seller on December 19, 2016 for $420,000.  Seller made representations and warranties about the business in the asset purchase agreement. However, James was not a party to the agreement, nor a guarantor of Seller’s obligations to the agreement.

After the closing Robert learned about the new competitor Workout Anytime; and more:

… (Robert) … learned of the loss of the Cal Laboratory account. … (Robert) … also learned of financial representations made pre-closing which gave the appearance that revenues and credit card benefits produced by … (James) … individually or by other entities which … (James) … manages or in which he holds an equity interest were produced by … (Seller) …, inflating the revenues produced by the purchased assets. Finally, it learned of fraudulent billing practices undertaken by … (Seller’s) … employees acting at the direction of … (James) … which were intended to artificially inflate revenues produced by the purchased assets while potentially defrauding insurance providers and the federal government.

James defended himself in part by arguing that he can’t be liable to Buyer because James did not sign the asset purchase agreement; nor did James guarantee Seller’s asset purchase agreement obligations.

The court was not impressed with this argument and ruled that Buyer could sue James for these actions:

Further, the Court rejects … (James’) … argument that … (Buyer) … is attempting to retroactively assert a personal guarantee into the contract. … (because James) … is not a party to the contract and is not subject to the allocation of risk created by the Representations Provision in that document.

Ultimately, the Court rejects the argument that … (James) … cannot be personally liable in tort to … (Buyer) … because … (James) … had a personal duty independent of … (Seller’s) … contractual duties not to make material misrepresentations in connection with the parties’ transaction, which … (Buyer) … avers that he breached by personally and actively engaging in misrepresentations and material omissions.

This United States District Court case is referred to as Younger Brothers Investments, LLC v. Active Enterprises, Inc, Civil Action No. 5:17-CV-317-JMH. and can be found at: https://scholar.google.com/scholar_case?case=12364756785803420287&q=%22asset+purchase+agreement%22&hl=en&as_sdt=2006&as_ylo=2018

Comment. Often the owner of a company selling its assets is added with the selling company as a party to the asset purchase agreement or, provides a personal guaranty for the selling company’s obligations under the asset purchase agreement. A nonowner is usually not a party or guarantor of seller’s obligations in an asset purchase agreement. Nevertheless, even an nonowner officer or manager of a selling company risks tort liability to a buyer if he or she is not truthful and candid about the target business.

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

Telephone:      714 273-6291

 

Posted in tort misrepresentation in M&A

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