This dispute stems from a written purchase agreement between Sellers and Buyer. Under this agreement, Sellers sold their interest in their technology consulting company, Target, to Buyer.
In the summer of 2012, Sellers began marketing their company for sale. Shortly thereafter, Sellers began negotiating the sale of Target with representatives from Buyer. Over the course of eleven months, the two sides negotiated and finalized the agreement whereby Buyer would purchase Sellers’ interest in Target in exchange for $3.15 million, stock in Buyer, and other compensation. The deal closed sometime between June 25 and June 27 of 2013.
Apparently, one of Owners of Buyer, the CFO of Buyer, resigned before the deal closed, and therefore, Buyer was obligated to pay the CFO over $1 million in severance benefits, which impacted the value of Buyer stock received by Sellers.
Sellers sued Owners of Buyer on June 23, 2016 in a Dallas federal district court for, among other claims, federal securities fraud; in particularly accusing Owners of Buyer of not telling Sellers about Buyer CFO’s planned pre-closing resignation.
Owners of Buyer argued that the purchase agreement had a disclaimer of reliance clause where Sellers had agreed to rely only on representations and warranties of Owners of Buyer that were contained in the purchase agreement. And therefore, anything said or not said during negotiations could not be grounds for a federal securities fraud claim, unless backed up by a purchase agreement representation and warranty.
The court held that Sellers could not sue Owners of Buyer under the federal securities fraud law for not telling Sellers about the CFO’s resignation.
The court ultimately said that whether the disclaimer of reliance clause barred Sellers’ federal securities fraud claims came down to whether it was reasonable for Sellers to rely upon what Owner of Buyer said during negotiations and due diligence that was not backed up by purchase agreement representations and warranties.
And whether it was reasonable to rely on statements made in negotiation and due diligence included looking at the complexity and magnitude of the deal, the sophistication of Sellers and Owners of Buyer and the contents of the purchase documents.
Applying this approach here, the court found that the purchase agreement disclaimer-of-reliance clause barred Sellers for suing for federal securities fraud for what was said or not said during negotiations and due diligence, as opposed to what was said in the purchase agreement representations and warranties.
The court concluded that it was not reasonable for Sellers, sophisticated and experienced in business, to rely on statements made outside the four corners of the purchase agreement. Even more so, as Sellers hired experts as consultants to aid them during negotiations and due diligence.
In addition, the court noted that Sellers and Owners of Buyer spent months negotiating the agreement and included six pages of representations that Owners of Buyer specifically warranted as correct and true, as well as financial documents, disclosure sheets, and balance sheets attached to the agreement.
This case is referred to as O’Connor v. Cory, Civil Action No. 3:16-CV-1731-B, United States District Court, N.D. Texas, Dallas Division (October 19, 2018).
Comment. A seller of a business that takes any part of the purchase price in equity of the buyer is also buying a business. Accordingly, a seller in those shoes must not only do due diligence on the buyer but also ask buyer to make representations and warranties about the condition of buyer’s business in the purchase agreement.
In this case Sellers wanted to sue Owners of Buyer under the federal security fraud laws for what was said and not said about the CFO resignation. However, the disclaimer of reliance upon statements made outside the purchase agreement, barred Sellers from doing so.
In 20/20 hindsight, Sellers could have included what is called a full disclosure representation in the purchase agreement where Owners of Buyer would represent and warrant that Owners of Buyer did not have knowledge of any fact that may materially adversely affect Buyer, that had not been disclosed in the purchase agreement.
Sellers could also have tried to include a “fraud carve out” in the disclaimer of reliance clause which would permit Sellers to make fraud claims against Owners of Buyer for statements they made which were not backed up with a representation and warranty in the purchase agreement.
By John McCauley: I help people start, grow, buy and sell their businesses.
Telephone: 714 273-6291
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