The perils of fraudulent misrepresentation in M&A transactions

A recent case before the High Court provides an interesting lesson for all those involved in M&A transactions. The High Court held that the buyer of a company was induced to enter into a share purchase agreement (SPA) by a fraudulent misrepresentation and was therefore entitled to rescind the contract. The decision makes its clear that no amount of exclusion clauses or other boilerplate provisions can protect a seller in a case of fraudulent misrepresentation.

Background – Erison Precision Holdings Ltd –v- Hampson Industries plc [2011] EWHC (Comm), 20 April 2011

In July 2009 Hampson Industries PLC made the decision to sell the entire issued share capital of its wholly owned subsidiary Hampson Precision Automotive Ltd (HPA), a manufacturer of components for the aerospace industry. Prior to entering into the SPA in June 2010, the buyer was provided with regularly updated profit and sales forecasts showing a year on year increase in sales by HPA to Cummins Turbo Technologies (Cummins) representing about 34% of projected turnover.

However, this information wasn’t entirely accurate. Cummins had been in communication with Hampson’s CEO, Kim Ward, since April 2010 concerning their decision to switch supplier by the end of August 2010. Indeed, the afternoon before completion, Mr Ward was alleged to have received an email from Cummins giving him formal notice of this. Despite recognising that this loss of revenue from Cummins would impact on the sale process, Mr Ward decided to keep this information to himself.

Inevitably, the buyer became aware of the position shortly after completion. It wasted no time in notifying Hampson that it intended to rescind their agreement on the basis that Hampson, and more specifically Mr Ward on its behalf, was guilty of fraudulent misrepresentation. The buyer was unable to bring a claim for breach of warranty as the warranties in the SPA did not extend to customer relationships or the future potential of the business.

Fraudulent Misrepresentation

To establish fraudulent misrepresentation, it must be shown on the balance of probabilities (the civil standard of proof rather than the criminal standard), that a false statement was made: (a) knowingly; or (b) without belief in its truth; or (c) recklessly, that is careless as to whether it is true or false. The person making the representation must have done so with the intent to deceive i.e. that it should be relied upon by the recipient.

Decision

The High Court granted the buyer’s request to rescind the SPA i.e. to set it aside and put the parties back into the position in which they were before the contract was made. The Court held that:

• the forecasts were statements of opinion which carried an implied representation of fact, namely that Hampson had reasonable grounds, or knew of facts, that justified the forecasts;
• it was irrelevant that Mr Ward did not deliver the forecasts to the purchaser himself or direct that they be so delivered;
• to establish fraudulent misrepresentation the buyer was required to prove one thing: that Mr Ward knew the forecasts were false and/or misleading, but nevertheless decided to stay silent in order that the buyer would continue to rely on them.

The reasons why Mr Ward had neglected to pass on the information from Cummins to which he had become privy were also analysed in detail. Mr Ward claimed to believe that Cummins had no intention to terminate their relationship with Hampson, were simply employing a commonly used tactic to negotiate a price reduction and, in any event, there was likely to be sufficient value in the business to justify the purchase price. The Court thought it more likely however that the absence of any relevant representations and warranties (together with the exclusion of liability for negligent and/or innocent misrepresentation) in the SPA led Mr Ward to mistakenly believe that Hampson was adequately shielded from any legal proceedings being brought against it by the buyer.

Comment

Ultimately, neither the exclusions of liability nor the absence of representations or warranties proved a valid defence for Hampson. As Hampson found out to its detriment, liability for fraud cannot be excluded, and although false statements may not give rise to claims for breach of warranty, an alternative claim in fraud cannot be ruled out.

Individuals involved in corporate deals (whether negotiating directly or on the periphery as was the case for Mr Ward) need to understand the risks of concealing or misrepresenting information that could affect a buyer’s valuation of the target company. In the context of a share sale, misleading statements or concealment may even give rise to criminal offences under section 397 Financial Services and Markets Act 2000 or other legislation, which can lead to imprisonment and/or fines for those responsible. All relevant information should always be fully and accurately disclosed to advisers, who can then provide guidance as to how the information should be presented.

For more information on the above, please contact Ben Turner or Joanna Duncan.