The Business I Bought Was Misrepresented. Claims Against the Seller

Start with the purchase agreement

Every claim a buyer has runs through the document both sides signed. Before anything else, four provisions have to be read with the facts in hand.

• Representations and warranties. The seller's statements about financial statements, undisclosed liabilities, material contracts, customers, litigation, taxes, employees and compliance. A misrepresentation that matches one of these is a breach of contract, with no need to prove the seller's state of mind.
• Survival, baskets and caps. Representations typically survive for a stated period, often 12 to 24 months for general representations and longer for fundamental ones. Indemnity usually applies only above a deductible or threshold (the basket) and only up to a cap, often a percentage of the price. These terms limit the contract claim, not necessarily the fraud claim.
• Exclusive remedy and fraud carve-out. Most agreements say indemnification is the buyer's sole remedy, and most then carve out fraud. The definition matters: some carve-outs cover only fraud in the written representations, some cover any fraud, and some define fraud to require actual knowledge.
• Disclaimer of reliance. A clause stating the buyer relied on no representation outside the agreement. This is the seller's main defense to any fraud claim based on statements made outside the four corners of the contract.

These four provisions, read together, tell a buyer whether the case is a contract claim within the caps, a fraud claim that escapes them, or both.

The contract claim: breach of representations

Breach of a representation is proven by comparing what the agreement says with what was true at signing or closing. If the seller represented that the financial statements fairly presented the company's results and they overstated revenue, the representation was breached. The buyer need not prove the seller knew. Damages are the loss caused, measured as the agreement directs, subject to the basket and cap, and the claim must be noticed within the survival period, usually by a written claim notice in the form the agreement specifies.

The contract route has two advantages. Knowledge is irrelevant, and the agreement may provide for attorney's fees or an escrow the buyer can draw on. Its disadvantages are the cap, the survival deadline and the exclusive-remedy clause. Buyers with large losses and small caps look to fraud. How contract damages are measured in Texas is covered in what damages a business can recover for breach of contract.

The fraud claims

Fraud claims need proof of the seller's knowledge or recklessness and of the buyer's justifiable reliance, but they are not confined by the indemnity provisions unless the agreement validly makes them so.

Fraudulent inducement

If the seller's false statement caused the buyer to sign, the buyer may choose between rescinding the purchase and keeping it while recovering damages. Rescission returns the business for the price, which is practical soon after closing and impractical after the buyer has run the company for two years. The remedy choice, ratification and the role of merger clauses are covered in fraudulent inducement in Texas.

Fraud by nondisclosure

Sellers more often omit than lie. A seller who provided customer revenue data while knowing the top customer had given notice, or who disclosed some litigation and not the serious case, has made a partial disclosure that Texas treats as actionable silence. The duty-to-disclose rules are in fraud by nondisclosure in Texas.

Statutory fraud

If the deal was structured as a purchase of stock in a corporation, or included real estate, section 27.01 of the Business and Commerce Code applies. It covers false representations of fact and false promises made to induce the contract, awards actual damages without proof of knowledge, adds exemplary damages where the seller had actual awareness, and awards attorney's fees, expert fees and costs to a prevailing plaintiff. An asset purchase of an LLC's business without real estate falls outside it.

Negligent misrepresentation

Where knowledge cannot be proven, a seller who supplied false information without reasonable care in a transaction in which it had a financial interest may be liable for the buyer's out-of-pocket loss. The claim carries a two-year deadline and no exemplary damages, and the economic loss rule limits it where the parties' contract covers the same subject.

The seller's defenses, and how to read them

Disclaimer of reliance. Texas enforces a clear and unequivocal disclaimer of reliance between sophisticated parties as a bar to fraudulent inducement claims based on statements outside the contract. In Forest Oil Corp. v. McAllen (Tex. 2008) the Texas Supreme Court listed what makes one binding: negotiated terms, representation by counsel, an arm's-length deal, parties experienced in business, and clear language. In Italian Cowboy Partners v. Prudential (Tex. 2011) the court held that a merger clause saying the contract is the entire agreement is not a disclaimer of reliance. Two consequences for buyers: a fraud claim based on the written representations themselves survives a disclaimer of outside statements, because the buyer was told it could rely on those; and a disclaimer does not protect a seller from a claim based on a representation inside the agreement.

"As is." A negotiated as-is clause in a commercial deal can defeat causation on a misrepresentation claim, but Texas courts will not enforce it where the buyer was induced to accept it by the seller's fraudulent representation or concealment, or where the seller obstructed the buyer's inspection.

Knowledge of the buyer. A buyer who learned the truth in diligence and closed anyway cannot claim reliance on the contrary statement. Some agreements include anti-sandbagging clauses barring claims on breaches the buyer knew of; others expressly allow them. The data room index and the diligence correspondence settle what the buyer knew.

Caps and exclusive remedy applied to fraud. Texas courts enforce negotiated limitation-of-liability clauses according to their terms, and the Texas Supreme Court has held a bargained-for clause barring punitive damages enforceable even against a fraud judgment. Whether a cap or exclusive-remedy clause reaches a fraud claim depends on its wording and on the carve-out. This is where the definition of fraud in the agreement decides the case.

Example

Suppose a Fort Worth buyer pays $6 million for a staffing company under an asset purchase agreement with a 10 percent indemnity cap, an 18-month survival period, an exclusive-remedy clause carving out "fraud," and a clause disclaiming reliance on statements outside the agreement. Eight months after closing the buyer learns that the seller's largest client had, before signing, told the seller's owner it was ending the engagement, and that the owner directed his controller to keep the client's revenue in the forecast. The financial statement representation in the agreement was accurate as to history, but the representation that there were no known material adverse customer developments was false. The buyer has a contract claim within the cap for that breach, and a fraud claim, based on a representation inside the agreement and on the nondisclosure, that the carve-out removes from the cap and the exclusive-remedy clause. The disclaimer of outside reliance does not help the seller, because the false representation is in the agreement itself. The owner's instruction to the controller, found on the server the buyer now owns, supplies knowledge.

The seller note, the earnout and the escrow

Buyers who discover misrepresentation often want to stop paying the seller. The agreement controls. Many notes and earnouts contain a right of setoff for indemnity claims, with a procedure: written notice, a dispute period, sometimes a requirement to escrow the disputed amount. A buyer who follows the setoff procedure is on solid ground. A buyer who simply stops paying without one invites a counterclaim on the note, often with attorney's fees and acceleration, and hands the seller the simpler case. Where an indemnity escrow exists, a timely claim notice preserves access to it; after the release date the money is gone. These steps are time-sensitive and should be taken with counsel before the next payment is due.

Evidence the buyer already holds

A buyer's position is unusual: it now owns the seller's former books, email and systems. Those systems should be preserved intact, including the former owner's mailbox, and reviewed with counsel for what the seller knew and when. The buyer's own diligence file is equally important: the question lists, the data room index with upload dates, the quality-of-earnings report, and the model showing how the price was built. A forensic accountant typically reconstructs the true financials and quantifies the difference between the business as represented and as delivered. Their role is explained in how forensic accountants are used in fraud litigation.

Deadlines

Three clocks run at once. The contractual survival period is the shortest and is enforced as written; a claim notice sent one day late on a 12-month representation is usually gone. Fraud and statutory fraud carry four years under section 16.004 of the Civil Practice and Remedies Code. Negligent misrepresentation carries two years under section 16.003. Where the agreement requires mediation or arbitration before suit, that procedure governs and the notice must be sent in the form it specifies.

When to involve a litigator

Before the survival period runs, before the next note payment, and before anyone emails the seller to "ask about" the problem. The order of the claim notice, the setoff notice, the preservation steps and the demand determines what the buyer keeps. Tina Wysk represents buyers and sellers in post-closing fraud and misrepresentation disputes in Dallas state and federal courts.