Commercial Law Update - Discovering two sets of accounts is a good ground for a purchaser to terminate a sale of business agreement

Commercial Law

Broughton v B & B Group Investments Pty Ltd [2017] VSCA 227

In the course of conducting a due diligence enquiry the purchaser of a hotel business discovered, among other things, that the vendor had kept two sets of books: one for production to the Australian Taxation Office and another for management purposes. 

The purchaser gave a notice terminating the purchase agreement, as it was entitled to do, and claimed the return of its deposit. The vendor alleged that, upon a proper construction of the termination clause, the purchaser was not entitled to terminate the agreement.

The vendor sued in the County Court of Victoria for damages for loss of the contract price and the purchaser counterclaimed for return of the deposit.

One might have thought that the discovery that a vendor had kept two sets of accounts would be a sufficient basis for a purchaser to conclude that it could have no confidence in the state of the accounts as a whole, and thus that any warranties as to the state of the business given by the vendor would be worthless. However the trial judge concluded otherwise:

Her Honour said this:

First, he asserts that he formed a total loss of trust in anything he had been told, which is focused on the revenue side only, and in particular having been told the figures would be $2.1 million for the current year. In fact the figure for revenue in the RoomMaster records was $2,123,715 for the financial year ending 30 June 2014, although less in the financial statements at $1,972,000. I do not regard these figures as showing a discrepancy reasonably giving rise to a total loss of trust in what he had previously been told. Further, although I do not mean in any way to condone what might have been understatement of income to the Australian Taxation Office, what [the applicant] was being told, in particular on mention of a cashbook being kept, was likely to indicate that real revenue was higher than he had been led to believe. Finally, as his stated plans on the purchase were to carry out a substantial upgrade so as to raise the hotel to 4 star-rating, the ultimate profitability was not likely to depend on the revenue being achieved by the [respondent] from the hotel in its current condition, except in the very short term. (emphasis added)

The Victorian Court of Appeal was less than convinced and corrected what, on any view, was a glaring error. Kyrou, Ferguson and McLeish JJA said:

137    Secondly, the reasoning applied by the judge in rejecting the applicant’s evidence that the discrepancies in the respondent’s three sets of financial records had caused him to lose trust in the veracity of the information provided about the financial performance of the Hotel business is, with respect, flawed. The judge’s reasoning, as set out at [117] above, was to the effect that the applicant should not have been concerned that the respondent had kept a cashbook because this indicated  that the ‘real’ — as distinct from the declared — revenue was ‘higher than [the applicant] had been led to believe’. Given that the purposes of the due diligence included ‘verification of the Business Records and all warranties ... given by the [Vendor]’ it is, with respect, illogical to suggest that the applicant was not justified in losing trust in the veracity of the financial figures. The discovery that a vendor may have two sets of accounts, one for the Australian Taxation Office, and one for management purposes, viewed from an objective commercial perspective, would be a cause for concern rather than comfort.

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