Legal Risks and Lessons Learned: An Analysis of Forward-Looking Statements in M&A

Introduction

The recent Federal Court case Optic Securities Australia 2 Pty Ltd v YC Investments Pty Ltd [2023] FCA 495 is a timely reminder of some of the legal risks with projections and other forward looking statements in M&A.  This is a highly contentious area in sale and purchase transactions, and the case contains several important warnings for both buyers and sellers in the market.

Background

Optic2 purchased all the shares in the STS Group from YC Investments under a contract that completed in November 2018. The contract contained a seller warranty that the information provided in the disclosure materials was:

• so far as the seller was aware, true, complete, and not misleading or deceptive; and
• where consisting of opinions, expectations, or beliefs, those matters were honestly held and arrived at on a reasonable basis after full enquiry (the contractual warranties).

The contract also contained a clause stating that:

• the buyer must notify the seller of any claim it has against it in respect of a breach of the contract as soon as practicable after it became aware of it;
• the buyer could not make a claim for breach of a seller warranty unless reasonable details of the claim have been notified to the seller within 18 months of completion; and
• a claim would not be enforceable unless legal proceedings in connection with the claim were commenced within 7 months after written notice.

In dispute was the accuracy of certain projections regarding the gross profit margin of the business.  After completion, the buyer claimed the seller had misled it regarding these projections and that this constituted:

1. a breach of the contractual warranties contained in the share sale agreement; and
2. misleading and deceptive conduct, which is prohibited under section the Australian Consumer Law. Importantly, the Australian Consumer Law states that, where a person makes a representation with respect to a future matter, and the person does not have reasonable grounds for making the representation, then this is taken to be misleading.

The seller then cross-claimed to recover a portion of the purchase price which the buyer was refusing to pay.

The Court rejected both of the buyer’s claims.  Instead, the Court decided the buyer was required to pay the outstanding amount of the purchase price claimed by the seller.  Charlesworth J found that:

• the seller did have reasonable grounds for making the statements in the gross profit projection. This projection was found to have been the result of the conduct of a number of personnel working in conjunction with each other under an appropriate system of delegation and deputisation.
• the buyer failed to prove its claim that the gross profit margin was derived from outdated data from project management software.
• in any case, the buyer had failed to prove the ‘true value’ (on its view) of the purchased shares; and also failed to prove it would not have entered the transaction were it not for the gross profit projection. This would have precluded the buyer from recovering substantial damages anyway.
• the claim for breach of the contractual warranties failed because the buyer did not notify the seller of the claim within the period permitted by the contract after becoming aware of the relevant facts. Additionally, the buyer failed to prove that the gross profit margin warranty was misleading.

Takeaways

The case demonstrates again some fundamental principles regarding projections and other forward looking statements, including that:

• because this is a fertile area of dispute, sellers should avoid making representations and warranties regarding forward looking matters (e.g. forecasts or projections) whenever possible;
• if a seller is obliged to make forward looking statements, then it is in the seller’s interest to obtain contractual acknowledgments from the buyer, that the buyer is not relying on these representations in deciding to enter the transaction;
• failing which, a seller should ensure it makes the necessary enquiries to demonstrate it has reasonable grounds for making the forward looking statement (as in this case). For example, the seller could obtain external professional advice or undertake other enquiries;
• the seller should document and retain evidence of these enquiries; and

Of course, from the buyer’s perspective:

• the buyer should treat forward looking statements with a healthy degree of scepticism;
• if the buyer considers it may have a claim in relation to such a statement (or any other matter), it should ensure any such claim is notified within the period required under the contract, in the manner required by it.