Careless talk costs consideration: misrepresentation in corporate transactions

The High Court has recently handed down two judgments relating to alleged misrepresentation in corporate transactions: Saxby v UDG Healthcare Holdings Ltd (2021) and MDW Holdings Ltd v Norvill (2021). Both cases serve as helpful reminders that the court's decisions in this context will usually turn on the facts: the court is plainly willing to consider not just the circumstances of a transaction but also the aptitude, knowledge, intention and attitude of those to whom and by whom representations are made.

Both cases also touch upon the scope of entire agreement clauses, emphasising the importance of effective drafting of boilerplate clauses.

Facts – Saxby

Saxby concerned the sale of an events management company, World Events Group Ltd (WEG), from a number of manager-shareholders to UDG. The sellers received initial consideration of around £13m upon completion, with a further £2.7m deferred and contingent upon WEG achieving certain profits within an earn-out period.

The buyer's intention post-sale was to merge its own events business, UPUS, with WEG and to retain the sellers in management roles. This was discussed at a meeting prior to completion, at which the buyer's representatives gave a presentation which related, in part, to the financial state of UPUS, which was obviously of significance to the earn-out target.

In the event, the earn-out target was not met. The sellers alleged that the buyer had overstated the financial performance of UPUS, and subsequently issued proceedings claiming that they had been induced to sell WEG on the basis of the buyer's fraudulent (or, alternatively, negligent) misrepresentations, which rendered the earn-out target unrealistic.

Facts – MDW Holdings v Norvill

In contrast, Norvill concerned breaches of environmental warranties, as well as misrepresentations given in response to due diligence enquiries. The subject company was G.D. Environmental Services (GDE), which the claimant, MDW, purchased from the defendants in October 2015.

In simple terms, GDE operated a waste management and disposal business that was subject to various environmental regulations. While GDE had the required consents, it was subject to weekly sampling which, between 2013 and 2015, showed that the level of contaminants in GDE's discharge exceeded the relevant limits. Throughout that period, GDE was engaged in correspondence and meetings with Dwr Cymru Welsh Water (DCWW) with a view to agreeing and implementing an improvement plan.

Meanwhile, the sellers entered into negotiations with MDW in August 2015. During due diligence, MDW requested details of all documents relating to any investigations or similar processes brought by regulatory or other bodies in relation to GDE. In response, the sellers (a) stated that consent levels were under review, and (b) asserted that there were no outstanding investigations. The sale and purchase agreement (SPA) also contained warranties relating to GDE's compliance with environmental permits and laws.

Predictably, following completion GDE was notified by DCWW that it was considering prosecuting GDE for various breaches of environmental regulations. The buyer subsequently brought claims against the sellers in respect of (a) breach of warranties and (b) misrepresentation.

Judgments

In both cases, the court found that there were actionable misrepresentations: in Saxby, on the part of the buyers, and in Norvill, on the part of the sellers. However, the decisions contrast in a couple of significant ways:

Effect of fraud

In Norvill, the court held that the sellers' misrepresentations were made fraudulently (that is, in the knowledge that they were false). Key to the court's decision was the fact that the representations were given in response to questions specifically posed by the buyer in the course of due diligence, which in itself indicated the importance of the responses to the buyer.

As a matter of law, a person who makes a fraudulent misrepresentation is presumed to have intended the other party to have acted in reliance upon it. In Norvill, the sellers were unable to displace that presumption on the facts.

Reliance

In contrast, the misrepresentations in Saxby were not fraudulent. The court therefore went on to give greater consideration to the question of whether the sellers had relied upon the misrepresentations in entering into the SPA.

In doing so, it found that:

• the sellers did not pay attention to points of detail during the financial presentation;
• the sellers were experienced business people, and one of them was actually a chartered accountant; and
• other factors induced the sellers to enter into the transaction.

The judge also found that the sellers failed to perform any due diligence on UPUS. On that basis, it could not be said that the sellers had relied upon the representations; rather, they could, and should, have taken steps to investigate the validity of the representations (and they may have done so, had they been sufficiently interested).

Entire agreement clauses

In Norvill, the court held that, although the SPA contained an "entire agreement" clause, it did not refer explicitly to reliance on pre-contractual representations or exclude liability for any such representations. A claim for misrepresentation had therefore not been excluded.

We understand that the SPA in Saxby contained a similar provision, albeit no point was taken in relation to it by the defendants (and one would imagine the court would have treated it in the same manner as in Norvill).

Practical implications

Misrepresentation claims will always turn on their own facts. However, there are three broad takeaway points in the context of corporate transactions from these cases:

• Parties must be honest during a transaction, and in particular during the due diligence process. Far better to work through commercial issues as they arise than to face significant liability for misrepresentation after the deal completes.
• Parties must be informed and adequate care must be given to both making, and responding to, due diligence enquiries, particularly in light of the weight afforded to them by the court. Areas of concern and importance to both sides must be pressed by legal advisers. Neither ignorance nor innocence are likely to be a defence to a claim in misrepresentation.
• In protecting against liability for misrepresentation, it is important to use language specifically directed at doing so, such as non-reliance or no representation statements, although in practice it is difficult to envisage a prospective buyer accepting wording which may have the effect of rendering the due diligence process redundant. Efforts should therefore be made to ensure any representations are made formally, either in responses to due diligence enquiries or in a disclosure letter.

Perhaps most importantly, the very fact that both matters went to trial, at undoubtedly huge cost to both parties in terms of time and money, highlights the imperative (on both sides of a transaction) of getting the due diligence process right in the first place.

Postscript: The parties in MDW were granted permission to appeal in respect of technical issues relating to quantum. We have not commented on the Court of Appeal judgment, as it does not relate to or affect the points discussed above.