Background: Due Diligence, Purchases and Sales of Business
In the sale of a New Jersey business, buyers normally perform due diligence such as inspecting profits, losses, revenue, expenses, bank accounts, tax returns and financial statements and the like. Contracts for the sale of a business often say that the buyer is not relying on a seller’s representations, but rather only on its own inspections. In many instances, conducting inspections and due diligence may bar recovery when the buyer believed going in to the closing turn out to be incorrect. The question then becomes, what if those mistaken beliefs were brought about by the seller’s own fraud?
Bridals Gowns Not What They Appear
Anwar and Donna Walid were looking to buy a business. Donna had worked at a high end retail clothing store in New York, studied textile design, and obtained a master’s degree in organization and development. Anwar, Donna’s husband, had a degree in electrical engineering and had worked in research and development for Lucent Technologies. They were highly educated people.
They learned from a website that “Irene’s Bridal Shop” was for sale and that Jim Hamdan was the “listing broker.” Irene’s Bridal Shop was owned by Irene Paster. Paster represented that Irene’s Bridal Shop had “annual sales of 582,500 and an annual operating profit of $289,445.” The parties signed the contract for sale for $700,000. Paster, both by herself and through her bank and Hamdam, provided the Walids with information about the business including tax returns, financial statements and bank deposit summaries. The gross revenues showed between $582,913 and $731,166 per year. The Walids reviewed this themselves. Their attorney recommended that they get a certified public accountant to review it, but they did not, relying instead on their own and their attorney’s examination.
The Walids purchased the business for $700,000, which subsequently failed. Upon examination, they determined that Paster had another business, Yolanda Couture, Inc. which manufactured bridal gowns. This other business deposited many of its receipts, indeed more than $300,000 per year, in Yolanda Courture, Inc.’s bridal shop’s bank accounts, drastically inflating gross revenue, and therefore its profits.
The Walids sued. The trial judge found that Pastor had clearly lied and was fraudulent in almost all regards. However, fraud requires “reasonable reliance” on defendants’ material misrepresentations. The judge found since the Walids had inspected the books and records and conducted due diligence, they could not have “reasonably relied” on Paster’s representations.
A Groom’s Belief in Bridal Lies Will Not Shield Her From Fraud
The Walids appealed. New Jersey ‘s Appellate Division agreed with the general proposition that if a buyer conducts its own inspections, in some circumstances that may prohibit it from suing the seller. However, when the buyer’s due diligence is defeated by the seller’s own fraud, especially when the due diligence consisted of examining the very books and records provided by the seller which it knew were fraudulent, there is no way that the buyer could have independently discovered the fraud, or the business’s true condition. Therefore, in such a case, the due diligence and inspections are no bar to recovering from the seller for fraud.
Likewise, while in a case between an honest buyer and seller, a “no representation clause” may bar recovery for breach of contract, if the seller made knowing misrepresetations, such a clasue will not bar a claim for fraud.
The Appellate Division summed it up well, explaining that the buyer’s good faith due diligence and inspections will not bar it from recovering in a suit for fraud against the seller when it was the seller’s own fraud that prevented the buyer from discovering the truth.
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