In contract law, parties have an obligation to provide and investigate relevant information before entering into an agreement. This is particularly true in mergers and acquisitions, where the seller's duty of disclosure and the buyer's duty to investigate are central.
The seller must share essential information about the target company so that the buyer can make an informed decision. At the same time, the buyer must carefully research the company, also known as due diligence, to make an informed decision.
In practice, the seller's duty of disclosure is often given more weight than the buyer's duty to investigate. This is because the seller usually has more knowledge about the company and any defects. If the seller withholds essential information or provides misleading information, he cannot rely on the argument that the buyer could have discovered this through investigation. However, a summary communication from the seller can create a heavier duty of investigation for the buyer.
Relationship duties to warranties
As for warranties, they directly affect the buyer's duty to investigate. When the seller gives specific warranties about aspects of the business, such as tax issues, the buyer may reasonably do less extensive research on those aspects. The buyer may rely to some extent on the accuracy of the warranties, but this does not mean that the duty to investigate is completely removed. There are situations where the buyer has a duty to investigate the accuracy of the disclosures provided.
For example, if the seller guarantees that the financial documents are correct, the buyer may choose to do less in-depth financial research. Should it later turn out that the guarantee was false, the buyer can sue the seller for breach of that guarantee. This was highlighted in the World Online ruling, where sellers were held liable for providing inaccurate financial information.
Warranties in an acquisition contract or information in a Disclosure Letter supplement the seller's duty of disclosure. The seller can explicitly disclose certain information or exceptions to warranties through the Disclosure Letter. The buyer can then no longer base a warranty claim on matters that have been explicitly disclosed.
Rollback of acquisition due to mistake
An agreement can be voided based on "mistake," meaning that a party entered into an agreement based on inaccurate information. In mergers and acquisitions, this can lead to significant consequences, such as reversal of the acquisition and repayment of the purchase price. In practice, however, reversing an acquisition can be complex, especially if the company has already been integrated into the buyer's business. This is often referred to as "unscrambling scrambled eggs."
Rolling back an acquisition is extremely difficult and can lead to disruptions in the operations of both buyer and seller, especially if considerable time has passed since the acquisition. For this reason, extensive due diligence is often done, and warranties and mistake are carefully negotiated and sometimes excluded in the acquisition contract.
Recently, the Supreme Court ruled on error following a share transfer. The Council ruled that as a result of providing incorrect information during due diligence, the contract must be nullified, even if the shares had already been transferred and the target company had changed in the meantime. The argument that undoing would be objectionable was rejected by the Supreme Court.
Conclusion
The duty to investigate and disclose, warranties, mistake and the possibility of voiding a contract are essential issues in M&A transactions. A thorough understanding of the legal obligations is crucial to avoid disputes and ensure a successful transaction.
