Right to cancel a contract in practice
ERLSON PRECISION HOLDINGS v HAMPSON [2011]
This decision is on the right to cancel (or rescind) a contract from the outset, in which it was demonstrated that this right can apply where a change in circumstances has been dishonestly concealed, which was important in the context of the contract in question. It showed the dangers of deliberately withholding information and how a company can be found liable for its employees’ acts and omissions.
Facts:
- In July 2009 H decided to seek a buyer for its wholly owned subsidiary, HPA. An information memorandum (IM) was prepared which included a forecast income statement. In mid-October 2009 the IM was initially provided, then updated and distributed to potential buyers including G.
- In late October 2009, representatives of G attended a presentation at HPA's offices showing figures incorporated from the updated IM. During the presentation G was told that H expected growth in the business done for C, HPA’s second largest customer. W, H's CEO, was aware of this presentation although he did not give it himself.
- Soon afterwards, G was able to access the HPA customer forecast, which showed that sales to C were forecast to represent between 34-40% of HPA's annual turnover from 2008/09 to 2011/12. This information, slightly updated, was again repeated in a subsequent presentation and an updated HPA customer forecast.
- In April 2010, G made an offer for HPA of £3.1m. A few days later W was told by telephone that C was terminating its supply arrangement with HPA. Nevertheless a further presentation still went ahead displaying that sales to C were forecast to be over £4m in 2010/11 and over £5m in 2011/12, (about a third of annual turnover).
- On 22 June 2010 C sent W a letter by email to officially confirm that after 31 August 2010 C would no longer submit orders to HPA.
- On 23 June 2010 the share purchase agreement (SPA) relating to the entire share capital of HPA was completed. Later that day, W learned of C's formal termination letter and forwarded it to G.
- H argued that until formal notice of termination was received, it believed that C had been using a tactic commonly employed by customers to threaten to withdraw future orders in order to achieve a price reduction and that at all times H (W) did not believe there was any real likelihood of C withdrawing its business. No relevant warranties had been given in the SPA and G had carried out its own due diligence. There had therefore been no breach of contract and no contractual entitlement to ‘terminate’ the SPA.
- G subsequently brought a claim for rescission (or cancellation) of the SPA on the ground that it had been induced to enter it by fraudulent misrepresentation.
Decision:
- It was not disputed that the customer forecasts provided carried an implied representation that H had reasonable grounds to justify the forecasts. It was also not in doubt that G relied on the forecasts and the implied representation they carried and that after 30 April 2010, the implied representation was false.
- The false statements made did not constitute a breach of any of the warranties given in the SPA, and an action based on innocent or negligent misrepresentation was precluded by a number of boilerplate exclusion clauses. G therefore had to establish fraud.
- To establish its case G had to prove, on a balance of probabilities, that W was aware that the forecasts were being communicated to potential buyers and that, knowing that they were false and/or misleading, dishonestly did nothing to correct them with the intention that the forecasts should be continued to be relied on.
- The Court rejected the argument that there was a genuine belief that C was engaging in a negotiating ploy to try to secure a reduction in price. W had known that revenue forecasts were being provided to potential buyers which suggested that C was the second largest of HPA's customers and that C had no reason to think that that state of affairs was likely to come to an end in the near future. He had known that there was to be a presentation to G on 17 May 2010 and must have appreciated that such forecasts would be provided to and would be relied on by G's representatives attending the presentation. He had also known after 30 April 2010 that those forecasts were, by that point, false and misleading. He had kept silent about C's termination with the intention that potential buyers should continue to rely on the forecasts he knew had become misleading.
- W knew all too well what effect C's termination would have had on HPA's prospects and must have appreciated that he ought to have reported the news imparted to him at the end of April so as not to mislead potential buyers. Accordingly the SPA was induced by a fraudulent misrepresentation and G was entitled to rescind the SPA and claim its purchase price back in its entirety.
Points to Note:
- Whilst it is unusual for rescission to be available to purchasers of companies following completion (the right to rescind usually having been lost because it is no longer possible for the parties to be restored to their pre-contractual position, or because the buyer is considered to have ‘affirmed’ the contract by continuing to run the company or business while it considers its rights), this case shows that in exceptional circumstances, it is in extreme cases a possibility.
- Exactly the same principles would apply to any commercial contract. Whilst rescission is comparatively unusual, as this case demonstrates, in appropriate cases it is an important remedy.
- This decision also illustrates that it is perfectly possible for a company to be held liable for the fraudulent acts and omissions of individual members of senior management. The right to rescind on the basis of fraud also applied irrespective of any contractual provisions to the contrary – as one might expect.