This article is co-authored by Ryan McMaster and Jessie McKenzie.
When buying property or a business, purchasers rely heavily on vendors to provide accurate due diligence information to verify the deal they have struck.
But what if their disclosures don’t provide the full picture?
In one recent case (Sullivan v Wellsford Properties Ltd), the High Court applied the principle of caveat emptor – ‘let the buyer beware’.
But the Court of Appeal disagreed with this narrow interpretation and said the responsibility for due diligence lay with both parties.
This case contains some important lessons that purchasers and vendors need to be aware of when it comes to due diligence.
This particular case involved the sale of a commercial property by way of a standard form ADLS Agreement for Sale and Purchase of Real Estate. As often occurs, the purchaser asked to carry out a satisfactory due diligence investigation before confirming the deal.
The purchaser asked about the total operating expenditure (OPEX) paid by the vendor so they could see the degree to which OPEX had been recovered from the building’s tenants.
In response, the vendor admitted a shortfall in recovery of OPEX from the tenants which prompted the purchaser to negotiate a decrease in purchase price. However, the vendor didn’t disclose that one of the tenants had challenged the OPEX allocated to it for the previous financial year.
Unaware of this, the purchaser confirmed the deal. But following settlement, the tenant in question negotiated a lesser OPEX allocation than the purchaser had assumed based on the vendor’s disclosed figures. This further decreasing the degree to which OPEX could be recovered.
Who’s At Fault?
The High Court applied the principle of caveat emptor (buyer beware). They ruled:
the vendor’s disclosure obligation was limited to providing information relevant to the due diligence investigation “as requested by the purchaser”.
by not specifically demanding to see the emails about the tenant’s challenge, the general inquiry into OPEX wasn’t enough to require the vendor to disclose this.
But the Court of Appeal disagreed.
They ruled the ADLS agreement created a detailed contractual relationship and the responsibility of carrying out a thorough due diligence process lay with both parties, not just the purchaser.
Because the impact of unrecovered OPEX on net revenue became the focus of the purchaser’s due diligence investigation, the vendor’s failure to disclose the tenant’s challenge was a breach of their due diligence obligation.
Justice Clifford clarified the standard to which vendors will be held:
“The extent of the vendor’s due diligence disclosure obligations are to be determined by an objective assessment of what a vendor, acting reasonably and having regard to the subject matter of the purchaser’s due diligence inquiries, would determine was relevant to those inquiries.”
The court ruled the vendor breached its disclosure obligations and acted in a misleading and deceptive manner under the Fair Trading Act 1986.
The director of the vendor was held personally liable due to his direct involvement in the sales process. This shows how seriously the Court of Appeal is about protecting the due diligence process.
Going forward, vendors need to ensure they take a more proactive approach when it comes to due diligence.
If you would like further advice on your due diligence process, please contact one of our experienced team.