The Consequences of Misrepresentations in the Sale of a Tech Company

Whether it’s a company buying out its competition or a corporate tech giant purchasing a business so as to integrate its assets with another company’s assets, the sale and acquisition of tech companies is a massive part of the technology industry with billions of dollars on the line.[1] While many of the major acquisitions that are successful become newsworthy, such transactions aren’t always as easy and straightforward as they may seem. Particularly, when a seller of a company has made material misrepresentations to the purchaser.

The Second Edition of the Restatement of Contracts broadly defines a misrepresentation as “an assertion that is not in accord with the facts.”[2] Within this definition lies a variety of different circumstances which give rise to the occurrence of a misrepresentation. In the context of a tech company sale, a misrepresentation can generally be classified as either being fraudulent or negligent. A misrepresentation is fraudulent when it is consciously false and is intended to mislead the other party.[3] In the case of fraudulent misrepresentation, “one becomes liable for breaching the general duty of good faith or honesty.”[4] However, where a party has failed to “exercise reasonable care or competence in supplying correct information,” such a party is liable for negligent misrepresentation.[5] As can be expected, the consequences that a misrepresentation can have are greatest in instances where a party has purposefully provided the other party with false information.

Representations and Warranties

While the details and arrangements concerning the sale of a business may vary greatly from one transaction to another, the commonality in all such dealings is that the buyer typically relies on the seller’s representations and warranties regarding the business affairs of the company. Often, such representations and warranties are supplemented with supporting documentation. However, this may not always be the case for every transaction or for every representation and warranty that is made concerning the business. Knowing the meaning behind such assurances as well as the consequences of relying on false assertions can be essential in avoiding potentially harmful deals.

Organization, Standing, and Power

A common preliminary assertion made by the seller is that the company actually exists and is in good standing in the jurisdiction that it was formed in. Additionally, the person signing on behalf of the company will often represent that they have authority to bind the company to the terms of the sale agreement.

Litigation, Compliance with Laws, Permits, and Business Restrictions

Whether there is, or has been, any claim, action, audit, litigation, proceeding or investigation against a company can make or break a deal. Similarly, a seller’s assurance to a buyer that the company is under no restrictions of doing business and that the company validly holds all necessary permits and licenses is likely to be an essential prerequisite for a buyer to be willing to enter into a transaction for the purchase of a tech company.

Financial Statements, Liabilities, and Tax Matters

The financial status of a business is often among the most important aspects that a purchaser would consider in connection with buying a company. Considering such importance, a potential buyer will typically require the seller to furnish supporting documentation concerning a company’s finances as a condition to closing the deal.

Assets, Intellectual Property, and Customers

Besides the financial condition of a business, another vital component of the purchase of a tech company revolves around the company’s assets. Assets can come in various forms including physical property, intellectual property and the company’s goodwill. Certain aspects such as physical assets and intellectual property can be well documented through records, ledgers and registrations. However, intangible assets such as a company’s goodwill, are not easily documentable and, as such, a buyer must typically rely on the representations made by the seller with respect to such assets.

Types of Remedies Available

The consequences of a misrepresentation concerning a matter in one of these sections can be catastrophic for the purchasing party. In such instances, the buyer may be unknowingly purchasing a company with legal and regulatory issues or entering a deal with a business that doesn’t rightfully hold title to what it warrants to be its intellectual property.

Damages

In the event a party is harmed by another party’s breach of an agreement, courts will look to compensate the injured party in an amount that’s equal to the injury sustained through what’s referred to as “compensatory damages.”[6] In some jurisdictions the court will award an injured party with the “benefit of the bargain” whereby the injured party receives the difference between the value of what was expected less the value of what was actually received.[7] While other jurisdictions compensate an injured party based on “out-of-pocket loss” whereby the injured party receives the difference between the amount that the party paid less the value of what was received.[8] Additionally, where there has been a finding of fraud, courts may potentially award punitive damages to punish the intentional conduct of the breaching party.[9]

Equitable Relief

In addition to the different types of monetary damages that may be available to a party that has been injured by another party’s fraudulent misrepresentations, other forms of remedy, such as equitable relief, may also be available. The availability of certain forms of equitable relief may be dependent on the particular misrepresentations that have been made, while others are general forms of equitable relief which may be available as a result of a party’s reliance on a fraudulent misrepresentation.[10]

Rescission, as an equitable form of relief, allows the injured party to rescind, or cancel, the agreement and further restores the parties to the position that they were in prior to having entered into the agreement.[11] This type of remedy is particularly useful in cases where the seller’s misrepresentation results in the buyer having purchased something that was not contractually agreed to.[12]

As applied to specific misrepresentations that may have been made, an agreement can also be voided or cancelled if the other party has made a misrepresentation that the company had been validly formed or that the company was in good standing at the time that the agreement is entered into.[13] Ultimately, the availability of equitable relief as a remedy depends on the facts of a particular case. For instance, in a case where the person signing on behalf of a company lacked the actual authority to do so, the consequences would depend if the signatory had the express, apparent or inherent authority to do so.[14]

Parties who have been wronged as a result of a misrepresentation in a company sale may pursue compensatory relief, punitive relief, or other equitable relief as applicable in the jurisdiction. Although certain relief and redress may be available for a party that has been injured as a result of another’s fraudulent misrepresentation in a tech company sale, best practice is to try and avoid ending up in such situations in advance of the sale. Prior actions such as performing the requisite due diligence and having a carefully crafted sales agreement are some of the most important steps that can be taken to help mitigate the risk of falling victim to misrepresentations before they happen.

[1] See generally, M&A Statistics, Thomson Financial, Institute for Mergers, Acquisitions and Alliances (IMAA) analysis, https://imaa-institute.org/mergers-and-acquisitions-statistics/ (2020). [2] Restatement (Second) of Contracts §159. [3] Restatement (Second) of Contracts §162. [4] See, Gibb v. Citicorp Mortgage, 246 Neb. 355, 371 (1994). [5] Id. [6] See McKnight v. Denny, 198 Pa. 323 (1901). [7] See Damon v. Sun Co., 87 F.3d 1467 (1st Cir. 1996). [8] See Strouth v. Wilkinson, 224 N.W. 2d 511 (Minn. 1974). [9] See Jugan v. Friedman, 646 A.2d 1112 (N.J. 1994). [10] Restatement (Second) of Contracts § 345. [11] RESCISSION, Black’s Law Dictionary (11th ed. 2019). [12] See, United States v. Jones, 176 F.2d 278 (9th Cir. 1949). [13] See, White Dragon Prods. v. Performance Guars., 196 Cal. App. 3d 163, 168-169 (1987). [14] See, 3 Business Organizations with Tax Planning § 48.02 (2020).



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