Client Q&A: I Bought a Business and the Seller's Representations Have Turned Out to be False

My company acquired another company. The seller made representations regarding the company's finances that turned out not to be true. What can we do?

Something that is litigated with surprising frequency is the situation where the seller of a company makes representations regarding something--typically the financial condition and assets of the company--and, after the sale, those representations turn out to be false.

Under New York law, a representation is part of the contract containing it, and if the representation is false, you can make a claim for breach of contract. All that you need to prove is that the representation was made and that it was false.

In particular, a purchaser may sue for breach of an express representation that the financial statements provided by the seller are in accordance with certain requirements when in fact they did not comply with those requirements.

How Long Do You Have to Bring Suit?

You have a limited time after the deal closes to bring a claim for breach of representations. Generally, a claim for breach of representations accrues--that is, it comes into existence--when the contract containing the representations is signed. This is true even if the effective date of the contract is earlier than the date the contract is signed.

It is very common for purchase agreements to limit the time a purchaser has to bring a claim to a much shorter period than the six-year New York statute of limitations. Such terms are, in general, binding, so it is important that you promptly ensure that the representations that have been made to you were true.

What if There Was Not a Specific Representation?

If you relied on representations from a seller that were not contained in the purchase agreement, you might still have a claim, but you could face significant obstacles.

First, if, as is very common, your purchase agreement provides that it constitutes the entire agreement between the parties and disclaims any representations other than those written in the agreement, it is likely that a court will enforce those terms and prevent you from bringing an action based on representations that were not in the agreement. However, a disclaimer of representations does not preclude a fraud claim if it does not specifically disclaim the representations. In other words, it must be specific.

Second, if you are buying a business, a court may find that you are a sophisticated investor, and as a sophisticated investor, you have a duty to exercise due diligence in investigating your purchase. That is, if you could have, through reasonable efforts, determined the truth of a fact, you cannot claim that you were defrauded because the seller misrepresented that fact to you. Or, as a recent appellate court decision puts it: "if the facts represented are not matters peculiarly within the defendant's knowledge, and the plaintiff has the means available to it of knowing, by the exercise of ordinary intelligence, the truth or the real quality of the subject of the representation, the plaintiff must make use of those means, or it will not be heard to complain that it was induced to enter into the transaction by misrepresentations." (Emphasis added).

A simple example can illustrate the general rule. When buying a small factory, you considered in setting the purchase price that the seller told you that there was $5 million worth of inventory in a warehouse located next to the factory. Later, you discovered that the warehouse was empty. A court likely will not entertain a fraud claim for the missing inventory because you failed to exercise reasonable due diligence when you did not look in the warehouse to confirm the presence and value of the inventory.

Conclusion

If a seller has breached a written representation in a purchase contract, you likely can sue the seller for breach of contract. But be sure you know how long you have to bring a claim because that time may be limited by the contract.

If the representation was not written in the contract, you may have a claim for fraud, but there are hurdles you may have to overcome.

Most important, if you are buying a business and you are relying on representations that the seller has made, make sure that you get them in writing. And use reasonable due diligence in checking facts material to the deal to which the seller will not make a representation.

We have extensive experience in litigating disputes regarding representations--written and unwritten--made in connection with the sale of a business. If you face such a dispute, feel free to contact us and we can advise you, too.