Misrepresentations in Business Sale Agreements

18th Jun 2018

The recent case of Shah v Hagemarad [2018] FCA 91, case concerned the sale of Subway franchise for $460,000 where the seller made certain representations to the buyer as to the average weekly and monthly sales. The contract provided that:

1. the buyer entered into the agreement as a result of their own due diligence;
2. any representation not warranted in the agreement was withdrawn;
3. each of the parties was released from all claims in respect of any representation not warranted in the agreement;
4. the buyer would not bring a claim against the seller unless based solely on and limited to the express provisions of the agreement.

Despite the buyer noting in correspondence that the practice of cash sales could allow for fake sales the buyer elected to rely on the combo reports and weekly inventory & sales report provided by the seller. It does not appear that the buyer engaged professionals to conduct due diligence into the business or its finances and merely used the reports provided by the seller and sat across from the store to observe the traffic into the store during lunchtime.

The buyer after purchasing the business subsequently discovered that the business averaged less than $12,000 weekly which was substantially below the average represented sales figures of just over $16,000 weekly. After considering the arguments of the seller the Court found that:

1. the seller sold the business during a period of cash flow problems and poor trading performance and that in order to inflate the sale price of the business he had created fake sales;
2. the buyer would never have agreed to purchase the business if he knew the sales were fake;
3. it was not unreasonable for the buyer to rely on the reports as provided by the seller as these reports were generated by the store for the purpose of reporting to the franchisor and were regarded by both franchisees and prospective purchasers as important and reliable records of a store’s sale performance;
4. the terms of the contract disclaiming liability and representations made before the contract were entered did not apply to exclude the liability of the seller in engaging in misleading and deceptive conduct by providing reports that misrepresented sales for the business in circumstances where they knew those documents were likely to be relied on by the buyer in entering into the contract,

and ordered the seller to pay the buyer $300,000 being the difference between the price paid by the buyer ($460,000) and the true value of the business ($160,000).

This case illustrates the importance of:

1. the seller of a business ensuring that the representations it provides to a buyer are correct as they may be liable for any misleading and deceptive conduct used to induce the buyer to enter the contract irrespective of any limits on liability or warranties included in the contract;
2. the seller ensuring it is able to substantiate any representations made regarding the business to the buyer;
3. the buyer undertaking thorough financial and legal due diligence prior to purchasing a business.

If you need advice or assistance in respect of the sale or purchase of a business including due diligence searches, please contact us.

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