Seller's Liability for Statements by Individuals on a Company Sale

In the recent case of Man Nutzfahrzeuge AG & others v Freightliner Ltd & others [1] , the High Court held that a seller of a company may be liable for statements made by the target company’s agents or employees.

In 1996, Western Star Truck Holdings Limited (Western Star) acquired ERF Holdings PLC (ERF). In 2000, Western Star sold ERF to a German company, Man Nutzfahrzeuge AG (MAN).

MAN subsequently discovered that (despite the appearance of its accounts) ERF was insolvent. MAN’s investigations revealed that ERF’s financial controller, a man named Ellis, had falsified financial documents and had fabricated financial information to ensure that ERF’s books balanced. However, Western Star had not been aware of Ellis’ actions or the discrepancies in ERF’s accounts when it sold ERF to MAN. Having discovered the true position, MAN took steps to stabilise ERF’s financial position but incurred substantial losses in doing so.

MAN sued Western Star for the losses it had suffered, arguing that Western Star was vicariously liable for the false statements made by Ellis during the course of the sale negotiations, that is, that ERF’s accounts gave a true and fair picture of ERF’s financial position. In particular, MAN argued that, by putting forward Ellis to answer questions about ERF’s financial position, Western Star had implicitly represented to MAN that Ellis was an honest and trustworthy employee when this was clearly not the case.

The High Court ruled that the critical question was whether Western Star had held out Ellis as having authority to speak about ERF’s accounts and financial position. Having heard the evidence, the court held that MAN had been induced to purchase ERF by fraudulent statements made by Ellis and that, whilst these statements had initially been made on behalf of ERF, Ellis had also acted as Western Star’s representative on two important occasions. The court held that Western Star was vicariously liable for the fraudulent statements that Ellis had made as its representative. The court also ruled that Western Star was therefore liable to MAN under the tort of deceit for all of the losses suffered by MAN as a direct result of entering into the share purchase agreement. Although the court has yet to make a final award, MAN estimates its losses to be around £350 million.

The following lessons may be drawn from this case:
• sellers may be vicariously liable not only for the fraudulent statements of their own employees but, in certain circumstances, for those of the target company’s employees. The case distinguished between those statements made by target company employees in response to due diligence enquiries (where the employee is more likely to be treated as speaking on behalf of the target) and those statements made during negotiations with the buyer (where the employee is more likely to be treated as speaking on behalf of the seller)

• although in this case the seller was held to be liable for statements made by a target company’s employee during the sale negotiations, this may not always be the case and it is a reminder for buyers to ensure that important statements made in the course of negotiations are distilled into the main agreement.

The case is also interesting on the issue of general disclosures. The seller argued that the disclosure of “books and records” as a general disclosure included the fraudulent accounting documents and that these would have alerted the buyer to the inconsistency with other financial information disclosed. The High Court held that “books and records” did not include the documents in question and, in addition, it was the view of the judge (obiter) that general disclosure did not include inferences to be drawn from those items.

This case is interesting when set along side the Court of Appeal decision in Infiniteland Ltd v Artisan Contracting Ltd [2]. That case was also concerned with disclosure of documentation showing the existence of financial irregularities in the context of a share purchase. In that case the disclosure in question sought to make general disclosure of “all matters contained or referred to in” six lever arch files supplied to the accountants and “of all matters contained or referred to in the documents contained in the Disclosure Bundle”. The court ruled that there had been adequate disclosure to the buyer’s accountants of the real financial position of the target, and their knowledge was imputed to the buyer.

The Infiniteland case is a good example of the dangers for a buyer of accepting widely drafted general disclosures and the dangers inherent in accepting, as general disclosures, documents supplied to a third party. The emphasis placed by the court on the fact that it would have been open to the buyer to refuse to accept disclosure in general terms by reference to what had been supplied and to insist on disclosure in relation to each individual warranty would seem likely to encourage buyers to insist on specific rather than general disclosure against the warranties. It also emphasises the advantages to the seller of spelling out that the buyer’s knowledge of a matter undermining the warranties includes imputed knowledge as well as actual or constructive knowledge

The other lesson from Infiniteland is that each case is different and that whether there has been adequate disclosure will depend on the facts of each case and the relevant wording in the share purchase agreement – something reinforced by the judge’s obiter comments on disclosure in the Freightliner case.

[1] [2005] EWHC 2347

[2] [2005] EWCA Civ 791