Withholding material information? The other side might be able to unwind the deal

UK-based law firm Wragge & Co. tells a story (with names withheld) of a corporate acquisition deal that went south because the seller withheld material information from the buyer concerning the subsidiary that was being sold. As a result, the buyer got most of its money back, plus attorneys’ fees.

The seller didn’t tell the buyer about a key customer’s defection

You might wonder what information the seller withhold that was so important. It was this: A key customer of the subsidiary had telephoned the seller’s CEO to say that the customer would be terminating its relationship with the subsidiary.

No one said anything about this to the buyer of the subsidiary. The CEO testified that he thought it was a negotiation tactic by the customer to force the subsidiary to cut its prices.

The buyer got most of its money back — for fraud

The contract for sale of the subsidiary didn’t include any relevant warranties covering the subsidiary’s customer relationships. That didn’t matter: the court found that the seller’s withholding of the key customer’s termination notice constituted fraudulent misrepresentation.

The court’s finding of fraud meant that the buyer of the subsidiary was entitled to rescind the contract for sale. That is, the buyer had the right to unwind the deal and put the parties in the same position as they were in before they signed.

According to the article, the parties settled — the buyer retained ownership of the subsidiary, but the seller refunded most of the purchase price and paid the buyer’s attorneys’ fees.

Would a no-reliance disclaimer have worked?

The seller might have been better off if it had included a no-reliance disclaimer in the contract. Such a disclaimer might take the form of a statement that neither party was relying, and each party agreed not to assert that it relied, on (1) any representation allegedly made by the other party outside the four corners of the contract, nor on (2) the completeness of information supplied by the other party.

But the law in general is that liability for fraud can’t be contractually disclaimed. My guess is that many courts would refuse to give effect to a no-reliance disclaimer when the seller intentionally withheld material information.

Lesson: If you have to ask whether to disclose ….

If you’re the cautious sort, a serviceable rule of thumb for situations like this might be as follows: If you have to ask whether to disclose information to your buyer, the odds are that you should, if for no other reason than to shield yourself from later fraud claims.

(Hat tip: Barbara Cookson a.k.a. @filemot.)