The Heritage Handoff Holdings, LLC v. Ronald Fontanella Case: Would a US$4.4 million misrepresentation be applicable in Québec?

The Heritage Handoff Holdings, LLC v. Ronald Fontanella Case:Would a US$4.4 million misrepresentation be applicable in Québec?

Julie Robert [1]
ROBIC, LLP
Lawyers, Patent and Trademark Agents

The case of Heritage Handoff Holdings, LLC v. Ronald Fontanella [2] takes place in the state of Delaware in the United States and involves a claim by Heritage Handoff Holdings, LLC. (the “Buyer“)for breach of contact and fraud under the Securities Exchange Act following the acquisition of the business of Rex Forge (“Rex”) for US$12 million from Ronald Fontanella (the “Seller“) on July 31, 2015 (the “Closing Date“).

The Purchaser alleges that the Seller made misrepresentations regarding its relationship with its customers and the condition of its equipment.

In the months leading up to the Closing Date, Rex had difficulties with its two largest customers (contract cancellation, dissatisfaction, postponement of orders). These difficulties were crucial for Rex, as these two customers represent more than 80% of its sales.

The Seller did not inform the Buyer of these difficulties and instead made representations to the effect that none of its 10 largest customers had, during the 12 months preceding the Closing Date, cancelled, diminished, modified or, to the knowledge of the Seller, threatened to cancel, diminish or modify its relationship with Rex or notified the Seller or Rex of any litigation. It had also made representations to the effect that any dispute was minor and had been or would be resolved favourably by Rex.

The issue of Rex’s lack of customer diversity had been raised by the Buyer as a potential risk to Rex. As such, it had insisted that representation of the Seller regarding its relationship with its 10 largest customers be a fundamental term of the Agreement.

The Court concluded that the Buyer had succeeded in establishing by a preponderance of evidence that the Seller had misrepresented and omitted material facts concerning Rex’s customers. During the due diligence period, the Seller failed to disclose the complaints and cancellations it received from customers.

The Court concluded that the Seller committed fraud under the laws of Delaware and relied on the following three facts to reach this conclusion:

1) It was shown that the Seller was strongly motivated to avoid a reduction in the sale price;

2) The Seller knew that its loss of customers would have been detrimental to the transaction and that this was a fundamental condition for the Buyer; and

3) The Seller knew from experience that difficulties with its customers was crucial information to disclose to the Buyer and that this would have lowered the selling price.

The Court defines the fundamental conditions as being so important that if they are not met, the transaction fails [3]. This qualification also allows this representation to be maintained for a period equal to the limitation period rather than for a period of 6 months, as is the case for other representations under the contract between the parties.

In analyzing Rex’s business relationships with these customers, the Court established that it was reasonable and necessary for the Buyer to rely on what the Seller was told, given that it could not directly address itself to Rex’s customers, and the confidential nature of the transaction.

The Buyer did not successfully prove its claim with respect to the Seller’s representations regarding Rex’s equipment. The Court determined that the Buyer had access to Rex’s equipment and maintenance records. In addition, the equipment had been appraised by the Buyer’s appraiser. With the information at its disposal, the Purchaser was in a position to inquire about the condition of the equipment, which had not been the case regarding customer relations.

Thus, for fraud under the Securities Exchange Act and for breach of contract by the Seller, the Court awarded the Buyer US$4.4 million in damages, bearing a compounded quarterly 5% interest charge.

Application in Québec

This case illustrates the importance of statements and representations included in an acquisition contract. Their use of the term “fundamental” also greatly affects the Court’s interpretation when the time comes to analyze the intentions of the parties. In Québec, the use of the term “fundamental” or “essential” is also of great importance. 

Under article 1385 of the Civil Code of Québec (“CCQ”), a contract is formed by the exchange of consent between the contracting parties. Consent may be vitiated by error, when the error relates to an essential element that determined consent under articles 1399 and 1400 of the CCQ. If the error is caused by the fraud of another party, then the consent is vitiated in all cases where, contrarily, the party would not have contracted or would have contracted on different terms under Article 1401 CCQ.

In Québec, a party whose consent has been vitiated by an error caused by the other party’s misrepresentation of an essential element that determined his or her consent may request the resiliation of the sale contract or a reduction of the sale price.

The case of Kruger Inc. Master Trust v. Kruger Inc. Gercotech Inc. (4335414 Canada Inc.) [4] is an interesting example of how this principle has been previously applied. In this judgment, the Québec Superior Court granted a buyer the amount of $6,395,000 as a reduction of the sale price following the false representations of the sellers regarding the power generating capacity of the power station. This was an essential element throughout the transaction and had been used to calculate the sale price. This judgment was upheld on appeal[5].

Conclusion

It is therefore just as important in Québec to pay particular attention to the representations and warranties included in a purchase/sale contract and to the attributions regarding the fundamental or essential elements of the transaction in question. This could have significant financial repercussions for both seller and buyer