Be upfront about risk

Rosie Clark

This article appeared in the Otago Daily Times, November 2015.

Our business clients strike deals with other businesses based on obtaining and reviewing as much information as possible. Information is essential to either eliminating risk, or pricing for it. Problems can arise where risk is not appropriately allocated, or where information is incorrect. These issues were explored in a recent decision of the High Court, Closurepac NZ Limited v WS 2014 Limited.

WS was in the manufacturing business, supplying closures and seals to the packing industry, like the foil seals used on juice bottles. In 2013 WS sold its business and assets to Closurepac for $820,000. Shortly afterward, Closurepac became aware of quality issues and its customers withdrew some work. As a result, Closurepac lost revenue while incurring additional costs.

Closurepac alleged that, in purchasing the business, it had relied on representations made by WS (or its agents and representatives) which had turned out to be false. Closurepac sought a remedy under the Contractual Remedies Act for misrepresentation, claiming the cost of acquiring a new machine as well as consequential losses to cover lost revenue and additional quality control costs.

Closurepac alleged that both written and oral misrepresentations had been made. The Court was not satisfied on the evidence that the alleged oral representations had been made and put them to one side. This should serve as a warning to purchasers. Any statements or information provided by a vendor that you are relying on should be recorded in the written agreement, preferably as a warranty. This applies for all types of agreements, from complex business transactions to buying a home.

The written representations relied upon by Closurepac were contained in an Information Memorandum that had been prepared by WS’s business broker. These includes statements that “The Wadding Shop had excellent plant and equipment and guaranteed quality and compliance” and that “the key assets of the Wadding Shop were modern as investment in new technology and equipment had been made consistent with the need to remain competitive and to meet changing customer requirements for bottle styles and designs”.

Closurepac alleged that the plant and equipment was “outdated, approaching the end of its useful life and unable to cut modern wadding materials”. Such condition could not be described as “modern” or “excellent”.

The Court considered whether words like “modern” or “excellent” could be statements of fact. Arguably, they are so general that they are better categorised as “mere puffs” that is, marketing language that cannot sensibly be taken literally. While the Court was not persuaded that the words, in context, were puffery, the Court was satisfied that the statements (with the possible exception of the description of excellence) were not false. The Court held that “any representation as to the quality of the machines must be read in light of their disclosed age and value”.

The state of the machinery had been brought to Closurepac’s attention. Closurepac’s director had toured the factory, and the Judge noted the makeshift repairs (including the use of binding twine and duct tape) must have been apparent to the director. Furthermore, of the $820,000 purchase price, only $250,000 was allocated to tangible assets (including plant and equipment), which was considerably less than the estimated replacement cost. The Judge commented that “had the equipment indeed been considered excellent and modern then it is difficult to accept that its value would have been downgraded as it was”.

It is apparent that even if WS had misrepresented the condition of the machinery in its promotional material, Closurepac entered the transaction with either their eyes wide open or deliberately shut to the condition of the machinery. In these circumstances relief under the Contractual Remedies Act is not available. Closurepac had the opportunity to negotiate specific warranties about the capability of the machinery, but for whatever reason did not do so. Risk could have been allocated through the use of vendor warranties in the sale and purchase agreement, or priced for by further reducing the amount of the purchase price allocated to plant and equipment.