Purchase price in aM&A transaction is normally fixed after factoring the risks and liabilitiesthat are being incurred by the buyer. Such risks and liabilities are arrived atafter a thorough financial and legal due diligence. A buyer demands numerousrepresentations and warranties as a means of assurance relating to severalfacets of the seller or target company in the definitive documents. Definitivedocuments in such transactions are usually an investment agreement, a share purchaseagreement or a business transfer agreement.
The Indian ContractAct, 1882 provides for consequences in case of misrepresentation and breach ofwarranties. In the event an agreement has been entered into by coercion, fraudor misrepresentation, the aggrieved party has the following remedies:
1. The contract shall be voidable at the option of the aggrieved party.
2. The aggrieved party may require specific performance.
3. There shall be a restitution for unjust enrichment by the parties.
The power to avoid acontract is not an unfettered right under the Act & the Act further providesfor an exception to the general rule, i.e., that if misrepresentation orfraudulent silence is capable of being discovered by ordinary diligence by theaggrieved party, then the contract cannot be avoided by the aggrieved party.
The term “ordinarydiligence” is not defined under the Act. However the phrase “ordinarydiligence” has been interpreted to mean “that degree of care which men ofcommon prudence generally exercise in their affairs, in the country and the agein which they live. These last words are quite material quite important, inthis case i.e. “in the country and the age in which they live” thus, what mightbe ordinary diligence in one country, be negligence, even gross negligence inanother country, be negligence, even gross negligence ”
In another case,warranties were given in a share purchase agreement as being subject to “mattersfairly disclosed (with sufficient details to identify the nature and scope ofthe matter disclosed) in the disclosure letter”. The Court laid down aqualitative test, which was broad in its scope and required the seller todisclose the matter fairly and in sufficient detail. However, the Court ofAppeal, in one case, rejected the qualitative tests and observed that adequacyof disclosure must be measured against the requirements of the share purchaseagreement executed between the parties and not against the requirement of anygeneral common law concept of “fair” disclosure.
The practicalimplication of the aforementioned judgments are that the buyer seeks fair andsufficient disclosure to identify the nature and scope of the matter disclosedor seek a specific disclosure against specific warranties. Another qualifier inthe definitive document is “what would constitute buyer’s knowledge,considering that due diligence is generally outsourced to a law firm or tochartered accountants. Therefore based on the interpretation of the aforesaidjudgements, it appears to be that, “knowledge of consultants and advisers” areexcluded from the “buyers knowledge”.
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