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Purchaser Due Diligence. Caveat Emptor – Buyer Beware!

September 2018

A recent High Court case reiterates how vital it is to be thorough in a due diligence investigation and in making the right enquiries prior to committing yourself to any purchase.

Background

The Purchaser had entered into an Agreement for the purchase of a multi-tenanted commercial complex from the Vendor for $5,350,000. The Agreement was conditional on the Purchaser being fully satisfied with all aspects of their due diligence investigation. The Agreement contained a schedule of Tenancies listing estimated operating expenses percentages for each tenancy, and the sale information memorandum contained a note that there is a $32,563 shortfall in operating expenses recovery from the tenants. 

The Purchaser had made numerous requests for information and had received answers which did not comprehensively explain the calculation of the shortfall of the operating expenses the Vendor recovered from its tenants when contrasted with the actual operating expenses incurred by the Vendor. 

The Vendor did not provide the financial statements of the business noting they were confidential, and only provided figures with caveats such as noting the costs having high fluctuation over the years, and not including any “wash up” which was yet to be done. Nor did the Vendor’s figures detail any internal management or additional costs. Throughout the numerous email exchanges, it appeared the Purchaser did not receive the actual operating expenses incurred, and the information received appeared conflicted.

Based on the provided information, the Purchaser’s valuer had noted that the actual shortfall in operating expenses is likely to be between $50,457 and $70,457 annually. Substantially above the advertised shortfall of $32,563. The Purchaser had also enquired “are there any disputes with the previous tenants”, to which the Vendor had replied “there are no outstanding disputes with the tenants.” The question whether the Vendor had or has any disputes with the current tenants was not asked.

The Parties proceeded to renegotiate the Agreement, re-signing the same for a discounted price of $5,035,000. 

Dispute

Following settlement, it was revealed that one tenant had indicated in two emails to the Vendor that they did not agree with the operating expenses charged to them. That tenant had now asserted to the Purchaser that, according to the Deed of Lease, it was not entitled to charge certain expenses nor charge expenses in relation to a common area which was undocumented in its Deed of Lease. In that tenant’s calculation, it had been overpaying its operating expenses, and rather than owing wash up to the new Landlord, it was entitled to a refund of $59,801.52 GST inclusive.

The Purchaser thereafter sued the Vendor for $428,337.43, being the reduced expected income over the term of the lease, plus costs and interest; claiming misrepresentation by silence and by providing misleading information, breach of the Agreement, and deceptive conduct under the Fair Trading Act 1986.

Decision

The High Court deferred to the long-standing principle of “Caveat Emptor (Buyer Beware)”. The Court held that the Vendor had no general duty to disclose any information. The onus is on the Purchaser to satisfy itself with all aspects of the Purchase, including any information it may require prior to completing a Purchase or entering into an Agreement.

A duty to disclose any pertinent facts can arise from:

  • A Party enquiring as to that fact; or
  • Having a requirement for disclosure in the Agreement.

In this case, the Purchaser should have:

  • Made a general request for all relevant information regarding operating expenses and its recovery; and
  • Asked whether there were any disputes with the current tenants. 

The Purchaser did not ask either. As such, the Purchaser simply did not ask the right questions to trigger any duty of disclosure from the Vendor.

Our Recommendations

We recommend you always take specialised legal advice and ensure you are satisfied with the following:

  • The Agreement has been drafted to your satisfaction, including the due diligence provision, any particular warranties and any requirements for disclosure;
  • Any information in respect of the Purchase is reviewed by your experts in that field to ensure there are no deficiencies in the information provided; 
  • Carefully review the Deeds of Lease of tenants, and any variations, to ensure that the facts match what is legally documented in the lease;
  • Take a proactive approach in making general inquiries and specific requests for information.

Finally, be absolutely satisfied with all the information you have on your investment prior to declaring an Agreement unconditional. Once the Agreement is unconditional, there is no going back!