Can you successfully keep quiet about issues when you sell a business?
The way company share sales are meant to work and the way they can end up applying are not always the same.
The way share sales should work is that problems ought to be disclosed before the contract is signed. There is a system within the English legal system designed to encourage disclosure as we explain below. There is often a price adjustment following disclosure.
The way share sales can work is faults are not disclosed and the buyer acquires shares for a price that does not take into account the warts causing loss. Unscrupulous sellers trade on the buyer not finding out or, if they do find out, not having the funds to pursue an action for loss.
In this insight based on our experience of dealing with varying sizes of companies across a range of sectors over the years we look at how loss will be dealt with under the UK legal system by considering:
- The disclosure letter and its relevance
- Common areas a buyer should request warranties on
- What do you do if the seller has swept dirt under the carpet?
- How much can I recover from the seller?
- Tactical considerations of a seller
- Ensuring that losses are kept to a minimum
- Recent case law
The disclosure letter and its relevance
The contract for sale of the shares, being the share purchase agreement, is negotiated between a buyer and a seller and will usually include a list of warranties. The warranties are contractual statements about the state of the seller’s business when it is purchased. If a warranty is untrue at the time of the sale and purchase, a seller is required to disclose why the warranty is untrue and this is done in a disclosure letter.
By a seller disclosing information against the warranties in a disclosure letter, his risk is reduced as a buyer is unable to pursue any claims against a seller if he suffers a loss for a breach of a warranty. A prudent buyer should consider that whilst a disclosure may mean there is an increased risk being purchased, a buyer can use this as an opportunity to negotiate a lower purchase price.
Common areas a buyer should request warranties on
Typically, a buyer should request warranty protection from the seller in connection with:
- the share capital of the company being purchased
- the accounts of the company being purchased
- financing and banking
- real property
- environmental issues
- commercial contracts
- intellectual property
The above list is not exhaustive and warranty protection required should always be tailored for the transaction at hand.
What do you do if the seller has swept dirt under the carpet?
If a seller has failed to disclose an issue to you meaning that a warranty provided by the seller when the shares were purchased was untrue, you have a possible claim against the seller. The next step for you is to show that you have suffered a loss. This may seem obvious but without suffering a loss, there is no right to pursue a claim for damages.
Damages for breach of warranty or inaccurate information from the seller?
Working out how much you can ask the seller to pay you is not easy to calculate. The usual method of valuing a loss is calculated by taking the market value of the company you purchased had the warranty been true and deducting the actual market value of the company you purchased. The difference between the two is the value you ask the seller to pay you. Performing the calculation will be a matter of debate invariably.
Tactical considerations of a seller
On the flip side, it is worth considering that a seller will likely argue that notwithstanding that he failed to let you know of the other company and its liabilities, you made a poor commercial decision and overpaid for the shares. To be successful at recovering any damages, you will need to demonstrate that there is a difference between the actual market value of the company you purchased and the value of the company you purchased had the warranty been true.
Ensuring that losses are kept to a minimum
The rules of the English legal system require that if you suffer a loss, that loss is kept to a minimum as a result of a breach of a warranty. Therefore, if you have suffered a loss like , you are required to take steps to mitigate losses.
For example, if the acquired company has undisclosed liabilities such as a bank loan which is accruing interest, just because you were not told of the liability does not mean that you can stop repaying the loan when it should otherwise be repaid. By stopping repayment, you may incur additional charges raised by the lender which may not be recoverable from the seller.
Using an incorrect method of valuing a loss can be costly, which is why we are at hand to guide you through the process.