In light of the recent HP Autonomy fraud trail, M&A teams are taking stock of the various fraud carve outs they rely upon, as the lack of precision in this area can undercut the waiver of reliance as well as the cap on indemnification.
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In the HP Autonomy transaction, the diligence missed (or ignored) a series of circular transactions - recording sales to channel partners that were later reversed. This trick was used to artificially boost the company's earnings before its sales to HP. |
Agreements are typically drafted with the phrase “except in the case of fraud”, but dealmakers are often unclear on what that actually means. The misstep here is that forensic diligence may be skipped if the deal team believes the legal team has drafted and negotiated protections.
This is of particular importance as most agreements include a disclaimer that representations outside of the contract are off limits post-close.
The seminal paper of this topic, “The Pesky Little Thing Called Fraud” by Glen D. West The Business Lawyer Vol 69 August 2014, outlines the benefit of more specific language that “specifies the scienter requirement (intentional or willful misrepresentation), specifies the requirement that the misrepresentation must be of “material facts”, and other structural elements that are important to negotiate, even when there is no reason to suspect a problem.
The most recent deal points study from SRS Acquiom provides a breakdown on the occurrence of typical fraud definitions.
For sophisticated dealmakers, the coordination between diligence and fraud protections may require some evolution in practice, coordination, and understanding.
In the Autonomy acquisition, the deceptions and misrepresentations lead to an $8b impairment charge and a decade of litigation that could have been avoided.
