Error in the event of a takeover - annulment or amendment of the agreement

Imagine that immediately after you have purchased all the shares of a company, it becomes apparent that a large number of clients have terminated their agreement with the company.

The seller failed to inform you of this and no information about it was made available to you on this matter during the due diligence investigation. Had you known this when concluding the deal, you would not have purchased the company, or at any rate, not at the same purchase price.

What to do?

Breach of guarantees

Firstly, you could claim compensation on the grounds of breach of a guarantee given by the seller in the purchase agreement. Whether this will succeed depends of course on the scope of these guarantees. If this claim is successful, compensation can be claimed.

Error

If a claim for compensation is not successful, you could invoke error.

Error exists if an agreement has been concluded based on a misrepresentation of the facts. This information must be of such importance that the purchaser, had he been made aware of this, would not have concluded the agreement, or at any rate not on the same conditions (but at a lower purchase price, for example).

Annulment of agreement following error

If an agreement has been concluded under the influence of an error, it can be annulled, which means that it will be deemed never to have existed. In that case, all acts must be reversed. In the event of a takeover this means, for example, that the purchase price paid to the seller must be repaid and that the purchaser must transfer the shares back to the seller. All other actions taken in that respect must likewise be reversed until the situation is the same as before the takeover.

Amendment of the agreement following error

Share purchase agreements usually exclude the option to annul. Besides, purchasers will not always benefit from an annulment of the agreement either. Purchasers will often prefer to retain the shares they have acquired. In such cases, purchasers will benefit more from amending the conditions of the agreement, for example an adjustment of the purchase price. The law offers a solution for this, as the agreement can be amended to remedy the loss suffered as a result of the error. This can be achieved by a proposal made in good time by the other party, but also by the court at the request of one of the parties involved. In such cases, part of the agreement will continue to exist and part will be amended, often resulting in a lower purchase price, thus restoring the contractual balance. This option is usually not excluded in the purchase agreement.

A court can follow the principles applied by the parties to calculate the purchase price, for example by adjusting the EBITDA used or a multiplier.  However, there are also other ways for the court to determine or estimate the extent of the loss suffered as a result of the error.

In practice we see that when negotiating a purchase agreement, parties often devote a lot of time and effort to defining the concept of loss and the contents of the guarantees and indemnities. A thorough due diligence investigation is also carried out in most cases. Fortunately, most negotiations are conducted openly and honestly, but it is good to know that invoking error can serve as a last resort in the exceptional situations where it turns out later that you have been dealing with a seller who has betrayed your trust.