Deliberate Deceit in a Business Acquisition
In most cases involving deception on the sale of the business, it is the buyer who complains that the seller has dishonestly over-valued the business. The recent case of Vald Nielsen Holding v Balderino is unusual in that it is the seller who complained that the buyer misled them by under-valuing.
This article simplifies some very complex facts and figures around this case. The numbers are high, but the principles would apply to any company, subject to one point below.
This was a buyout of a business by its own directors. Directors usually know more than the owners of the company. There was also a crisis because the bank had demanded repayment of borrowing.
In 2009 the directors carefully constructed a detailed report that misled the shareholders into believing the company was doing very badly and had poor prospects for the coming years. The shareholders therefore formed a low idea of the company’s true value. They looked for other buyers, but on the information available it was unattractive and there was only one other interested purchaser. The shareholders preferred to sell to their trusted management team.
The directors formed a new company and offered to buy. In very simple terms, the seller received £6 million for shares that, if the true position had been known, would have been valued at £16 million in 2009. In 2014 the buyers sold their interest for £40 million.
The Judge found that there had been deliberate deceit and the shareholders should be compensated.
How much should they receive?
If the directors had not misrepresented the position then the shareholders would not have sold at that time and at that price. It was more difficult to determine exactly what would have happened.
The normal rule on misstatement by a seller is that compensation is based on the difference at the date of sale between the true value of the assets and the price paid. The court decided that the same general principle should apply here. So on the simplified figures, the difference between true value £16 million and price paid £6 million was £10 million.
However, the case did not end there.
The court looked to see if there was another date to value the loss, but there was no immediately obvious alternative that could be justified. What about valuing the shares in 2014? This would set the loss at £34 million! Too much had happened in five years and the bank would not have waited. The court was not satisfied that the shareholders would have held on to sell in 2014- or that their shares would have been worth £40 million if they had still owned the business. It needed a clear-cut position to justify departing from the usual rule.
The court also considered whether the shareholders would have been able to obtain the best possible price in 2009 if only they had known the true position. This was uncertain. In particular, the bank wouldn’t wait for payment so the shareholders needed to sell fast. Sale elsewhere would have meant a time-consuming due diligence exercise by the purchasers. A sale under time pressure meant a weak negotiating position and a lower price. Slightly surprisingly, the court also took into account the fact that the shareholders had previously tried to find investors in the company and their approach had been “somewhat amateurish”; they had not engaged professionals, merely approached contacts who might have been interested. Therefore, the Judge ruled that the shareholders would not have been able to get the full true value of the shares even if they had known the true position- they would only have got 75%. The judge called this a modest discount. The shareholders would have sold for £12 million. They “only” sold for £6million so their loss was £6 million. This is the award made. (The “modest” discount cost the shareholders £4 million).
The shareholders tried one more argument. The directors were in a position of special trust and confidence because they had far greater knowledge of the company’s true position than the shareholders, particularly in circumstances where they were offering to buy shares. Therefore, they argued, the directors owed a “fiduciary duty”, similar to that owed by a trustee. If so, the directors should pay not only for losses on sale, but should also account for all of the profits that they had generated as a result of their deception, based on the eventual sale for £40 million. This would have produced a huge compensation claim.
The Judge disagreed. The courts have never imposed this level of duty on a director of a large company. There was nothing so exceptional to make this case different.
Was justice done?
The shareholders were put back in the position that they would have enjoyed if there had been no deception, so far as the court could do this.
On the other hand, the directors, as the result of that deception, put themselves in a position where they were able to generate significant profits, even after paying £6 million compensation. I also suspect that the directors were, at least partially, to blame for the “crisis” caused by the bank calling in payment; a factor that significantly reduced the compensation that they were ordered to pay.
I mentioned that there might be a difference in cases involving smaller companies. Directors wanting to buy out the shareholders of smaller companies should be cautious. The Judge said that in small, close companies there is often a close personal, or family relationship between director and shareholder, so the court will be much more inclined to find a fiduciary relationship. A director who tries the same trick on a buyout of a small company may find himself having to account for all the profits he makes later.
Stephen Allen, partner