A primer on misrepresentation and fraud in the sale of a business in California

Do you have grounds to recover in a lawsuit for misrepresentation? This article may help you to decide whether to reach out to an attorney.

There are steps you can take during the purchase of a business that can help to reduce the risk of future litigation. Performing proper due diligence can greatly help anticipate future problems and discover the financial performance, goodwill and reputation of a business. But misrepresentation, fraud, or failure to disclose can affect the sale and subsequent performance of a business no matter how well due diligence is performed.

If you believe you may have suffered financially due to the misrepresentation of a business' finances, you may be wondering about potential legal options. Below is a brief explanation on misrepresentation during a business sale to help you to understand if you have a claim worth pursuing.

Elements of misrepresentation under California law

Under California law, in order to recover money damages for intentional misrepresentation, you must establish that:

  • The seller made a misrepresentation by lying, concealing, or not disclosing a material fact,
  • The seller had actual knowledge of the falsity,
  • The seller intended to have you rely on the falsity,
  • You justifiably relied on that misrepresentation;
  • Because of the misrepresentation you suffered damages.

It may help to explore the above elements in more detail. Misrepresentation includes outright lying, but is not limited to it. If a seller has knowledge of a "material fact" that will affect the future performance of a business, the seller must disclose that. A material fact is anything that you would reasonably want to know about a business that would influence your decision to purchase. For example, if the seller knows a large client is opting out of a contract but misrepresents this information during the sale, it is a material fact.

Keep in mind that the seller is not liable for statements of opinion regarding future performance. "The business is poised to take off" is not a misrepresentation even if untrue because it is an expression of opinion. Concealing or falsifying financial information, on the other hand, are grounds to recover under California law.

Sellers can avoid liability for intentional misrepresentation by showing that they had no knowledge they were presenting false information. However, if the seller relied on false or misleading information without justification, then the seller can be liable for negligent misrepresentation. In other words, if the seller did not take reasonable care or was incompetent in verifying the information expressed during the sale, then you may be able to recover under negligent misrepresentation.

Finally, you must show that you justifiably relied on the misleading information and you suffered harm as a result. In general, under California law you are not prohibited from recovering if you fail to discover an intentional misrepresentation by relying on the information you were given. However, if you fail to investigate a negligent misrepresentation, that could prevent you from recovering damages in a lawsuit.

Speak to an experienced business litigation firm

We invite you to give us a call for a free legal consultation.  This brief overview is not intended as legal advice; whether you have the grounds for a lawsuit depends on your individual circumstances. If you have further questions on whether to pursue a claim of misrepresentation, contact an experienced attorney familiar with business sales disputes to discuss your legal options.

The Buffington Law Firm, P.C., handles business litigation matters throughout Orange County, California.

Keywords: Misrepresentation, fraud, sale or transfer of a business, due diligence, failure to disclose.