Cases reinforce the importance of doing your diligence!
Summary
Businesses and properties are generally sold “as is, where is” or with limited warranties. It is up to the buyer to make their own investigations and satisfy themselves as to the condition and value of what they are buying.
The old caveat of “buyer beware” can come back to bite buyers who do not do their due diligence, as was exemplified in the following cases.
Asahi & the Purchase of Independent Liquor
In 2011, Asahi bought Independent Liquor from Pacific Equity Partners (PEP) for approximately $1.5 billion.
Following the acquisition, Asahi made a claim against PEP (amongst others) on the basis that they had engaged in misleading and deceptive conduct by significantly inflating the EBITDA of Independent Liquor during the sale process and during Asahi’s due diligence.
Asahi alleged that PEP made false representations to it, including forecasting earnings of approximately $125 million in the year leading up to September 2011, when the true forecast should have only been $83 million.
Asahi claimed approximately $700 million in damages and interest from PEP, calculated as the difference between the forecasts and the valuation.
Channel Stuffing
Asahi claimed that PEP had engaged in a practice known as “channel stuffing” in order to inflate its forecasts in the lead up to the acquisition. Channel stuffing entails giving customers incentives to bring forward ordinary sales so that the sale can be captured within a particular month or period.
PEP’s Defence
PEP defended the claim on the basis that channel stuffing is a standard commercial practice that is engaged in for a variety of reasons, and in any event Asahi had access to more than 6000 financial documents and had “all necessary means, resources and opportunity available to them to review, consider and assess” the financial representations made by PEP.
The Settlement
Asahi ultimately settled their claim against PEP outside of court for $199 million, being approximately 30% of the total losses claimed.
What does this mean for you?
This case highlights the importance of undertaking thorough legal and financial due diligence when purchasing a business, or otherwise structure the deal in order to minimise your risk, such as by including an earn out and extensive warranties where ever possible. Even if you obtain warranties, you must ensure that the seller will have the resources to indemnify you in the event you need to make a claim. To that end, warranty and indemnity insurance could be a worthwhile consideration.
Subsequent purchaser has no remedy against Builder for Defective Building
CDG Pty Ltd (CDG) carried on the business of consulting engineers and designing foundations for warehouses and offices. CDG built a commercial building on land owned by a trustee of a property trust (Trust). Before undertaking the building, CDG recommended to the Trust that soil samples be taken to ensure that the planned foundations were stable, however the Trust instructed CDG proceed without it.
The land was later sold by the Trust to Woolcock Street Investment Pty Limited (Woolcock).
The contract for the sale of the land did not include any warranty that the building was free from defects and there was no assignment of rights that the Trust may have against others, such as CDG.
Following the purchase, the building began suffering substantial structural distress.
The Claim
Woolcock made a claim against CDG to recover their loss and damage to the building, on the basis that CDG owed it a duty to take reasonable care in designing the foundations for the building.
Decision
The Court held that whilst builder of a residential dwelling may owe a duty of care to subsequent purchasers, builders of commercial buildings do not owe any duty of care to subsequent purchasers.
The Court found that Woolcock’s ability to protect itself as a commercial investor was an important consideration in arriving at this conclusion. The Court held that a subsequent purchaser of a commercial building has means of protection by obtaining warranties from the vendor, by having the building examined by relevant experts, or taking an assignment of the vendor’s rights against the builders and others.
What does this mean for you?
This case highlights the importance for purchasers of commercial properties to conduct due diligence, obtain suitable warranties, and take out sufficient insurance. Courts are taking the view that commercial investors have the resources necessary to protect their own interests, and the law will not assist those who fail to do so.
If you require assistance in conducting due diligence or structuring a transaction so as to reduce your risk, please contact us today.