Due Diligence and real estate transactions: Always know what you are getting into

This column was originally published on the Real Estate News Exchange (renx.ca).

When buying a business as part of a real estate transaction, buyers need to do their due diligence to make sure they understand what they are buying. This may seem obvious to some, but buyers don’t always take this step and instead rely on sellers’ representations instead of doing their own homework. This, in turn, leads to conflict and often results in buyers finding themselves on the wrong side of a bad deal that they cannot get out of.

That’s what happened in two recent Ontario court decisions, where real estate deals involving the sale of businesses went sour after sellers misrepresented them. Although both decisions reinforce the buyer’s responsibility to exercise due diligence, the court went both ways in assigning blame.

In Wen v. Gu, two parties have entered into a purchase and sale agreement for the purchase of a commercial building and the accompanying business. While the parties were negotiating the sale, the seller made certain statements about the income generated by the business, which the buyer relied on. Before signing the agreement, the seller provided the company’s financial documents. The buyer was therefore given the opportunity to verify the statements that were made before the conclusion of the agreement.

The buyer subsequently refused to complete the sale and alleged that the seller had instigated her into the deal by distorting the company’s income. The buyer then sued and alleged that the seller had made fraudulent misrepresentations about the business and claimed that the buy and sell agreement was hampered as a result.

At trial, the judge ruled in favor of the seller and ruled that the buyer had the opportunity to verify the statements regarding the income generated by the business and could not blame the seller for his own lack of due diligence. It was therefore ruled that the buyer had broken the contract by not concluding the transaction.

The buyer appealed and the appellate court overturned the trial judge’s decision on the grounds that at trial the seller had admitted that he had indeed distorted the company’s income during the negotiation of the deal. agreement. Since there had been a confirmed misrepresentation, it was deemed unfair to blame the buyer despite the lack of due diligence.

More recently, in 10443204 Canada Inc v. 2701835 Ontario Inc., two parties found themselves in a similar dispute over the purchase of a business as part of a real estate transaction, which ended in a very different outcome.

In this case, the business was listed on Multiple Listing Services (“MLS”) and the buyer discovered it in May 2019 through an MLS search. A meeting was then arranged with the buyer and seller through the listing agent, who was also present. The buyer claimed that during the meeting the seller alleged that the business was profitable and made some gross income per month. Based on these statements, the buyer made an offer to purchase the business.

A conditional buy and sell agreement was signed, in which the seller made a written commitment which stated that “the business has been carried on in the ordinary course and all financial statements and other information provided to the buyer are true, exact and correct with all material respects ”. The agreement also gave the buyer the right to independently verify the income generated by the business before closing the deal.

The buyer didn’t actually review any of the financial statements, they just reviewed a one-page financial summary that the listing agent prepared with the seller’s information. The statement also contained a term that said the buyer (or their agent) “shall verify” the information. The buyer did not hire their own agent and instead relied on the listing agent’s statements. The buyer also did not request additional financial information or take any action to have the income independently verified in accordance with its rights under the contract of purchase and sale.

Upon closing of the transaction, the buyer paid the purchase price through an upfront lump sum payment and accepted a repossession mortgage by the seller (“”VTB“). The buyer also gave the seller a promissory note and a personal guarantee for the remainder of the purchase price due.

Shortly after closing, the buyer learned that the monthly income generated by the business was significantly less than the amounts represented by the seller. After discovering this, the buyer immediately defaulted on the VTB payments. The Seller then brought an action for the unpaid amounts due under the VTB, the promissory note and the personal guarantee.

At trial, the court ruled that whether or not the seller made a false statement about the company’s income at the initial meeting, the buyer could not be deemed to have relied on such statements in a legal sense. of the term. According to the buy and sell agreement, the buyer had the right to independently verify the income and the agreement also included a “whole agreement clause”, which stated that there was no had no representations or external agreements forming part of the transaction. It was also noted that the buyer was given the opportunity to use their own agent and conduct their own due diligence prior to closing the deal and they chose not to do so.

In the end, the court sided entirely with the seller and the buyer was ordered to pay the amount owed from the purchase price and had to repossess the business.

Since these decisions are rather at odds with each other, this raises the question of which reasoning is more correct. On the one hand, these decisions seem to suggest that, if a seller admits to distorting a company’s income, the buyer may be able to opt out of the transaction on that basis. On the other hand, if the seller protects himself sufficiently by forcing the buyer to do his own due diligence, the seller cannot be held responsible even if he may have distorted the company beforehand.

These decisions demonstrate that due diligence is essential when purchasing a business as part of a real estate transaction. Buyers should also give themselves the option to opt out of the deal if the numbers don’t match. Sellers, on the other hand, can protect themselves from liability by including a full agreement clause in the purchase and sale contract. If either party skips these steps, buyers and sellers can find themselves on the wrong side of a failed deal.

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