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Posted: May 10, 2017

Client Q&A: My Company Acquired Another Company And Now I’ve Found Out That The Seller Lied To Us About Its Business And Finances. What Can We Do?

My Company Acquired Another Company And Now I’ve Found Out That The Seller Lied To Us About Its Business And Finances. What Can We Do?

By Niall D. O’Murchadha

When one business buys another business or its assets, the buyer sometimes (often) finds out later that the seller told it things that were not true. And although you might expect the laws dealing with such disputes to be simple and straightforward, they are very much not. Rather than trying to predict the outcome of any particular dispute, this Q&A will lay out some of the issues that make this area of law so complicated.

Breach of Representations and Warranties

Initially, the easiest claim to assert is for breach of contract—if statements made in the “Representations & Warranties” section of the agreement are not true, or the seller fails to comply with some future obligation set forth in the agreement, the buyer can sue for breach of contract.

Fraudulent Inducement

But what if the false statement was not included in the text of the contract, but were made instead during pre-contract negotiations (false statements in the seller’s business records, for example)? Or what if the false statement was made intentionally to deceive the seller? Or what if a merger clause disclaims reliance on any statements that were not written into the agreement? Or what if the limited remedies for breach of contract would not compensate the buyer for its entire losses? What can the buyer do then?

In such cases, a second remedy is available, namely an action for fraudulent inducement, which is in essence a tort claim where the buyer alleges that it was tricked into signing a contract in the first place. Making a claim for fraudulent inducement can be a more attractive option for a buyer: additional remedies for fraudulent inducement include rescission (unwinding the entire contract) and various forms of consequential damages (such as lost opportunities) that are usually not available in a straight breach of contract claim. Under certain circumstances, a fraudulent inducement claim can even result in an award of punitive damages.

The elements of a claim for fraudulent inducement are deceptively simple—1) a false representation of material fact, 2) known by the utterer to be untrue, 3) made with the intention of inducing reliance and forbearance from further inquiry, 4) that is justifiably relied upon, and 5) resulting in damages. But although asserting a fraudulent inducement claims sound like it should be easy, it is anything but—pleading a fraudulent inducement claim that can withstand a motion to dismiss is one of the most complicated undertakings in New York commercial law.

Issues With Fraudulent Inducement Claims

There are several reasons for this.

First, in an action involving a contract, fraudulent inducement has an additional element: the buyer must allege a misstatement or breach of duty that is “collateral to the contract.” And this element has given rise to a broad and conflicted body of law—New York courts just cannot agree on what “collateral to the contract” actually means. For example, some New York appellate decisions hold that an intentional misstatement in a contractual warranty gives rise to a fraudulent inducement claim—if the seller had not lied about some specific present fact about the business, the buyer might not have bought it. But other courts (sometimes even the same courts) have reached the opposite conclusion—because a warranty is part of the contract, it is not “collateral to the contract.” Similarly, some court state that as a definitive matter of New York law, a present misstatement of intent to perform a contractual promise (for example, that the seller knew perfectly well that it would not pay certain corporate debts in the future, or would not compete with the buyer’s business after the sale) gives rise to a claim for fraudulent inducement, while other courts are equally definitive that a present misstatement of intent to perform does not give rise to a claim for fraudulent inducement.

Second, in addition to the “collateral” question, a fraudulent inducement claim must be pleaded with particularity. In other words, a buyer may not simply allege that a statement was false and that the buyer reasonably relied upon it—it must allege facts sufficient to support that allegation, such as when the statements were made, how the buyer knows or suspects that the seller actually knew the statement was false when it was made, and how the buyer’s reliance was “reasonable.” Each one of these issues gives rise to its own complications—there is a large body of law on whether a complaint properly alleges that reliance was, in fact, “reasonable.” Was the buyer required to perform its own investigation, and if so, how in-depth was that investigation required to be? Should the buyer have demanded specific written promises that the suspect statement was true? Similarly, a “present intent not to perform” cannot simply be alleged—the buyer must say how it knows that the seller did not intend to perform as promised.

Third, because this field of law is so complicated, a potential plaintiff needs to give serious thought to where the action should be filed. Depending on the facts of the case and minor differences in each court’s precedents, bringing the action in one New York State county as opposed to another, or in federal court as opposed to state court, could affect the outcome considerably.
For these reasons, it is very difficult to say definitively what facts can or cannot support a fraudulent inducement claim. But it can be said with perfect confidence that an experienced commercial counsel is essential, both to draft the complaint and also—perhaps even more importantly—to oppose the inevitable motion to dismiss.

Conclusion

Schlam Stone & Dolan has such experience, both in advancing and in dismissing claims for fraudulent inducement of contracts. If you have questions, please contact us and we can discuss the specific facts of your case in detail.

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