Rescinding a share purchase agreement for fraudulent   misrepresentation

In Erlson Precision Holdings Ltd (formerly GG 132 Ltd) v Hampson Industries plc, the High Court held that the buyer of a company was induced to enter into the share purchase agreement by a fraudulent misrepresentation and was entitled to rescind the contract.

Recission is the retrospective avoidance of a contract. It takes effect from the time when the contract was made, so that the contract is deemed not to have been made at all.

In the above case, it would have required the seller to repay to the buyer the £2.5 million purchase price and for the buyer to return the shares to the seller. However, before the seller's appeal decision was heard, the parties settled out of court. They agreed that it was in their and the target's best interests that the target should be retained by the buyer and the seller paid £1.5 million to the buyer in damages with a contribution to its costs.

Briefly, the facts of the case were that a listed Plc ('Seller') decided to find a buyer for its wholly owned subsidiary ('Target'), a manufacturer of components used in the production of turbochargers. During the sale process:

	• over a period of 9 months commencing October 2009, the Seller provided the buyer ('Buyer') with various income and customer forecasts by presentation and/or by information memoranda, including in respect of one major customer, CTT;
	• the Seller's CEO was aware that updated forecasts had been shown to the Buyer forecasting a 34 per cent growth in annual turnover from CTT during 2010/11 and 2011/12;
	• on 30 April 2010 CCT told the CEO that it would be terminating its supply arrangement with the Target by end of August 2010 and the decision was final, leaving the CEO fearful that the loss of the customer would leave the Target "unsaleable";
	• prior to completion of the sale, the CEO did not communicate the loss of the CTT contract to the Seller's Board. He was due to leave end July 2010;
	• no warranty was given by the Seller on the accuracy of the management accounts or possible customer claims or disputes ;
	• CTT had become concerned that potential buyers of the Target were being misled. It made repeated requests of the CEO to confirm that its termination with the Target had been relayed to the Seller's board;
	• one day prior to completion of the sale, CTT officially confirmed in writing its termination and that as agreed in the previous conversation it would be effective on 31 August 2010; and
	• later, during the same day that the share purchase agreement was completed (23 June 2010) but after it was completed, the CEO learned of CTT's termination letter and forwarded it to the Buyer,.

The Buyer sought to rescind the share purchase agreement on the grounds of fraudulent misrepresentation given the CEO's failure to disclose CTT's decision to exit its relationship with the Target.

The Seller's Chairman (based on information supplied to him by the CEO) stated that the CEO did not believe that there was a real risk that CTT would terminate its supply arrangement and that the threat was a tactic commonly used to withdraw work to achieve a price reduction.

Given the lack of warranties, the false statements made in the forecasts did not constitute a breach of any of the warranties given in the share purchase agreement. Further, an action based on innocent or negligent misrepresentation was precluded by a number of boilerplate exclusion clauses, none of which were effective to exclude liability for fraud.

Lord Herschell in the case of Derry v Peek (1889) App Case 337 stated that "to prevent a false statement being fraudulent, there must, I think, always be an honest belief in its truth".

If an individual, in the position of the CEO, knew that a forecast has been falsified by events to which he was privy but remained silent intending that the forecast should be relied on by persons to whom the forecast was directly communicated, dishonesty on the part of that individual will have been proved without it being necessary distinctly and separately to show a conscious awareness of a duty to correct the statement.

The CEO had known since 30 April 2010 that the forecasts were false and misleading and he must have appreciated that those forecasts would be provided to and would be relied on by the Buyer's representatives attending the various presentations. He had kept silent about CTT's termination with the intention that potential buyers should continue to rely on the forecasts he knew had become misleading.

The conclusion was that the share purchase agreement was induced by a fraudulent misrepresentation and the Buyer was entitled to rescind the agreement.

However, rescission may not always be available to buyers of companies or businesses following completion. The right to rescind for fraudulent misrepresentation may be lost where:

	• it is no longer possible for the parties to be restored to their pre-contractual position (i.e. if the business has moved on since sale due to new contracts being signed or varied); or
	• the party to whom the fraudulent misrepresentation was made has affirmed the contract (i.e. continuing to run the business while considering its rights); or
	• there has been undue delay in bringing the claim following the discovery of the fraud (even a matter of a few weeks could defeat a rescission claim); or
	• a bona fide third party has acquired rights under the contract (i.e. a buyer has sold or purported to sell on the business).

Dee Sian
MH Corporate