Page 58 - M & A Disputes

Identification of Material Misrepresentations and Fraudulent Misrepresentations

In evaluating the transaction, the practitioner should consider evidence regarding whether the buyer had
knowledge of the material misrepresentations.

A material misrepresentation may cause a buyer to reach a conclusion different from the conclusion that
would have been reached in the absence of such a misrepresentation. For example, a buyer may have de-
termined a different purchase price for the target had it known of the material misrepresentation(s) made
by the seller. Black’s Law Dictionary defines a material misrepresentation, as it relates to contracts and
torts, respectively, as follows:

 "A false statement that is likely to induce a reasonable person to assent or that the maker knows
is likely to induce the recipient to assent."

 "A false statement to which a reasonable person would attach importance in deciding how to act
in the transaction in question or to which the maker knows or has reason to know that the recipi-
ent attaches some importance."

The practitioner may wish to consider the concept of materiality; however, the practitioner should be
cautious of the fact that materiality from an accounting viewpoint may not correlate with what is materi-
al to the transaction in dispute.

Sometimes, materiality may be defined within the acquisition agreement. If this is the case, the practi-
tioner should adopt the agreement’s definition of materiality when evaluating the transaction.

If materiality is not defined by the agreement, the practitioner should consider materiality from all per-
spectives, including authoritative accounting guidance, the Securities and Exchange Commission (SEC),
and the court’s interpretation (including rulings by the Supreme Court).

From an accounting standpoint, materiality is defined within Financial Accounting Standards Board
Concepts Statement No. 2, Qualitative Characteristics of Accounting Information, as "[t]he magnitude
of an omission or misstatement of accounting information that, in light of the surrounding circumstanc-
es, makes it probable that the judgment of a reasonable person relying on the information would have
been changed or influenced by the omission or misstatement."

Further, SEC Staff Accounting Bulletin No. 99, Materiality states that "[m]ateriality concerns the signif-
icance of an item to users of a registrant’s financial statements. A matter is ‘material’ if there is a sub-
stantial likelihood that a reasonable person would consider it important."

As previously mentioned, it is not uncommon for an acquisition agreement to include a provision that
sets a certain dollar limit, limiting the amount to which a buyer can recover from any indemnity claims
brought against the seller. However, in most cases, the dollar threshold limit does not apply if it can be
proven that the seller made intentional or fraudulent misrepresentations to the buyer or vice versa.

The practitioner should understand that fraud is a legal term, and he or she should not provide an opin-
ion about whether fraud occurred. For purposes of determining damages, it is the practitioner’s role and
responsibility to understand the legal theory of the fraud as it relates to the matter at hand.

Black’s Law Dictionary defines fraud as "[a] knowing misrepresentation of the truth or concealment of a
material fact to induce another to act to his or her detriment."

56 © 2020 Association of International Certified Professional Accountants