Absence of Full Disclosure Costs Company's Buyers
13th June 2017Back to articles
Company sales are often concluded with an 'earn-out' arrangement, by which the sum paid to the vendor varies according to how well the business which has been sold does for a period of time after the sale.
These arrangements are a frequent source of dispute, as a recent case illustrates. It involved the sale of a marketing agency in 2011.
The agency was being merged into another agency and there was an earn-out arrangement in place and careful warranties had been drafted to protect the vendors' positions. This was especially in point because the sum the vendors would receive depended on the earnings of the merged agency.
The purchasers failed to disclose to the vendors that their relationship with their agency's major client was becoming difficult and that that work was likely to dry up after the merger.
Whilst the warranties given contained adjustments for the potential effect of the loss of two of the agency's major clients, they were not constructed on the basis that the loss was likely or foreseen.
This cut the payment under the earn-out arrangement and the vendors went to court to claim that the sum payable should have been calculated differently. They claimed damages for the loss of the deferred consideration for the sale of their shares which resulted.
The buyers argued that they had not breached the warranty they had given and that, in any event, the warranty was unenforceable.
The arguments over who knew what about what were lengthy and convoluted and led to a judgment more than 300 paragraphs long, in which it was concluded that a warranty relating to the disclosure of material facts had been breached and that the warranty provisions were legally binding.
The vendors were awarded £2.6 million.
Jonathan Bailey, Head of Commercial says "When selling a business, a carefully worded sale agreement is absolutely essential and, as in this case, can operate as a significant protection for vendors and buyers alike."
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