A Barley Grain of Truth
The recent case of Cargill Australia Ltd v Viterra Malt Pty Ltd was a very large and hotly contested proceeding between two multinationals. The buyer paid $420 million for a malt business and discovered after completion that the business had been manipulating malt test results and misleading customers about the quality and type of malt supplied to them (and as to the use of additives in the malting process). The Court awarded the buyer damages in the sum of $168 million plus interest from the completion date in the sum of $124 million (plus costs).
Blame the employees
The seller issued third party claims against a number of executives of Joe White at the time of the acquisition, asserting that if the allegedly questionable operational practices did in fact take place, any such conduct was the conduct of Joe White and its executives, but not of the seller.
In its third party claims the seller sought to be indemnified by those executives in the event the seller were held to be liable to the buyer.
All of the seller’s third party claims against the executives were dismissed by the Court, save for one against a particular executive who, the Court found, had breached his employment contract and failed to act ethically, honestly and in the best interest of the seller (by making misleading representations and failing to disclose relevant information to the seller). However, no damages award was given against such executive because the seller failed to prove that his conduct caused the loss, i.e. the seller failed to prove that if the executive had made the seller aware of the questionable practices, the seller would have (a) disclosed such matters to potential purchasers, including the buyer, (b) amended the terms of the Acquisition Agreement before it was entered into, including the warranties, (c) investigated the questionable practices, and (d) caused Joe White to cease the questionable practices.
The sale was run as a two-stage “blind auction”. In the second stage the buyer had offered $405 million but at the eleventh hour the seller called the buyer’s bluff by misrepresenting that higher bids had been received at or around $420 million and that the buyer needed to pay an additional $15 million to secure the acquisition of Joe White. As a result the buyer increased its final bid by $15 million.
The Court accepted the buyer’s claim that in calling its bluff in this way the seller had engaged in misleading and deceptive conduct, and the Court held that the buyer was entitled to recover the additional $15 million by way of damages. However, the Court held that this $15 million loss was subsumed in the $168 million compensation awarded for the primary claims.
The quantum of damages ($168 million) was the Court’s finding (based on expert advice) as to the difference between the purchase price of $420 million and the true value of the Joe White business at the time of completion (such value being the price which would be struck between willing but not anxious buyers and willing but not anxious sellers in the position of the bargaining parties at the relevant time).
The buyer was Cargill Australia Limited and the subject business was that of Joe White Maltings Pty Ltd (Joe White), an Australian company founded in Ballarat, Victoria, in 1858, which produced malt from barley procured from Australian barley fields and then sold it to customers (mainly brewers and food manufacturers, such as Heineken, Asahi, Lion Nathan, SAB Miller, Coopers, Sapporo, Carlsberg, Kirin, and the Nestlé Group. Joe White had an excellent reputation, its operations were very successful and at the time of the sale Joe White was the largest maltster operating in the Asia Pacific region.
The transaction involved the sale of 100 percent of the issued capital of Joe White, together with a transfer of assets not owned by Joe White but used by Joe White exclusively in connection with its business.
Some takeaways from the case on risk mitigation in the context of business sales are set out below but of course a commercial approach needs to be adopted and it will not be practical to implement all of these ideas in all cases.
1. Before putting a business on the market for sale, a seller should audit itself (i.e. undertake “vendor due diligence”) to:
unearth and address any issues a buyer might find during the buyer’s due diligence;
ensure that the seller accurately presents the business to prospective buyers; and
verify the contents of the Information Memorandum (see comment below).
2. To control and manage the representations made by a seller to prospective buyers:
Prospective buyers should be asked to sign appropriately worded non-disclosure (confidentiality) agreements.
The seller should prepare and issue a carefully worded Information Memorandum (even if not legally obliged by legislation to do so) containing financial, operational, market and legal information about the business, and set up a Data Room containing relevant documents.
Each material statement made in the Information Memorandum should be verified and the verification recorded in an internal IM verification table.
Each warranty made in the sale contract should be verified and the verification recorded in an internal warranty verification table.
The seller should have a protocol governing who speaks to the prospective buyers, what representations they can make, the manner in which representations can be made, and who prepares and signs off on responses to questions from prospective buyers.A common approach (at least in the preliminary phases) is to make no oral representations and instead to invite written questions and answer them in writing in carefully worded and vetted responses.It is common for corporate advisors or investment bankers to act as intermediaries to field questions and then liaise with management in formulating responses (but ultimately the shortlisted or final bidder will usually want to meet with management before making a firm commitment to buy).
Management should flag commercially sensitive information and deal with it separately.For example, it could be withheld until late in the process when the prospective buyer has confirmed that it has completed its due diligence and (subject to a review of the commercially sensitive information) that it is ready to sign a sale contract.Originals or copies of documents containing commercially sensitive information should not be provided to a prospective buyer; instead, the prospective buyer should be shown the documents at the premises of the seller or the seller’s advisor (and should not be given the opportunity to take copies with them or to make copies).
3. It is important to ensure that information provided is accurate.It is also important to ensure that all material information is provided because failing to disclose material information to a prospective buyer can amount to misleading and deceptive conduct, misrepresentation and/or deceit (and did in this case).
4. An up-to-date business plan should be prepared (with appropriate disclaimers) to show to prospective buyers.The plan is often attached to or incorporated into the Information Memorandum, together with cashflow forecasts. Usually at least 3 years of historical results are provided to prospective buyers.
5. It is advisable to give assurances to management of the subject business, and to provide them with financial and other incentives linked to a successful sale and the amount of the sale, as in most cases a sale will not be successful without their cooperation, input and continued involvement after the sale.
6. While they are good to have, disclaimers, liability limitations and similar provisions in sale contracts or information memoranda are certainly not fail safe and other avenues of risk mitigation (like those alluded to in this article) should also be followed.
7. A buyer should undertake due diligence before agreeing to buy a business (and engage advisors to assist with this).Failing to do so is very risky and can (and often does) end in tears.
8. Executives of a seller or company being sold (or related entity) could get sued by the buyer, or by the seller (as they were in this case).Even if an executive is ultimately exculpated by a Court, the costs in defending such an action can be crippling.Structuring aside, it is important that executives are adequately covered by Director and Officer Insurance (also known as Management Insurance), for both potential liability and defence costs.Executives should also enter into appropriate Deeds of Indemnity and Access with their companies.
9. Obviously, a seller (and executives) should not engage in misleading or deceptive conduct, or try to call someone’s bluff using deception.
10. Where the equities are against you, beware the law.
See our Business Transactions webpage here.
Subscribe to our newsletters here.
If you would like to discuss any aspect of this article with us, or share your own experiences, please contact Rod Stumbles at +613 8692 7255 or here.
This article provides general information only and is not intended to constitute legal advice. No lawyer-client, solicitor-client or attorney-client relationship has been created between us. You must not rely on the contents of this article, whether as an alternative to legal advice from a lawyer or other professional legal services provider or otherwise. You should not take, discontinue or refrain from taking any action because your understanding of the contents of this article, including without limitation delay seeking legal advice or disregard legal advice. If you have any specific questions about any matter, you should engage us or other lawyers or other professional legal services providers to provide you with the necessary advice. Keep in mind that you may be facing important deadlines so you should not delay in engaging someone to provide you with the advice.