Misleading Conduct in the sale of a commercial property and director personal liability

In the recent Court of Appeal case of Sullivan v Wellsford Properties Ltd [2019] NZCA 168, the Court decided that when a vendor withheld information from the purchaser of a commercial property, the vendor:

The Court also found that the sole director of the vendor company was personally liable under the FTA (jointly with the vendor company).

The background facts

The property was a commercial property located north of Auckland in Wellsford. It had seven commercial tenants including a Caltex service station.

The vendor company decided it was time to sell the property, hoping to get around the $6m mark based on the annual net revenue ($405,551) and a rate of return of between 6-7% percent.

An experienced property investor group expressed interest and after some negotiation on the price entered into a sale purchase agreement to buy the property at a purchase price of $5.25m.

The agreement included a standard 15 working day due diligence condition for the benefit of the purchaser. This condition was added to give the purchaser time to get more information to assess the commercial viability of the property. The wording of this due diligence clause was a key consideration for the Court.

Since the purchase price was based on the annual revenue, the purchaser understandably wanted detail about the lease arrangements with the commercial tenants. This included an enquiry into the amount the tenants were contributing towards the shared operating expenses (OPEX) for the common areas of the property.

The purchaser asked a number of questions about this issue and eventually discovered that, because of deficiencies in the lease documents, the vendor was not able to pass on all of the OPEX costs to the tenants. This meant that there was a shortfall in OPEX recovery which affected net operating income (which had dropped from $405,551 to $384,200 when factoring in the non-recoverable OPEX costs).

After further negotiations the vendor and purchaser agreed on a reduced purchase price of $5.05m based on the lower income revenue and a rate of return of approximately 7.6%.

The information that was withheld

However, what the vendor and its director did not disclose during the due diligence period was that there was a current dispute with one of the key tenants, Caltex, about a recent annual wash-up invoice for OPEX.

Caltex had questioned the invoice and signalled that it was unfair and would not be paying it until issues under the lease were resolved. This meant that the recoverable OPEX figures disclosed by the vendor during the due diligence period were in dispute.

The purchaser only discovered the existence of this dispute after the purchaser had confirmed the agreement as unconditional.

After settlement, the purchaser then had to resolve the dispute with Caltex. The outcome of that dispute was that going forward, Caltex would pay even less OPEX resulting in a reduction of the overall annual revenue for the property.

The purchaser then sued the vendor and its director for loss caused by the decrease in value of the property at the time of purchase.

The High Court decision

The matter came before the High Court in 2014. That Court took a narrow interpretation of the due diligence clause and held that the clause only required the vendor to disclose information if specifically requested.

Although the purchaser had asked questions that were relevant to the issue of OPEX, the Court decided that the purchaser had simply not asked the right questions.  Accordingly the vendor did not need to disclose the fact of the OPEX dispute with Caltex.

In coming to this view, the High Court placed significant emphasis on the doctrine of caveat emptor or ‘buyer beware’.

It also followed that the High Court did not think the vendor had been misleading or deceptive under the FTA. The High Court signalled that any attempt to hold the director personally liable under the FTA was doomed to fail.

Court of Appeal decision

The purchaser then appealed to the Court of Appeal. The Court of Appeal disagreed with the High Court’s conclusion and said that due diligence is an increasingly important feature of modern contracting and facilitates the responsibility of a purchaser to take care and make informed decisions (to satisfy the buyer beware doctrine).

The Court noted that the wording in the clause obliged the vendor to “provide the purchaser with any information held relating to the property relevant to the due diligence investigation” and should not be limited by the ‘buyer beware’ doctrine. 

The extent of the vendor’s disclosure obligations were to be determined by an objective assessment of what a vendor acting reasonably and having regard to the subject matter of the purchaser’s due diligence enquiries, would determine was relevant to those enquiries.

In this case the Court considered the current OPEX dispute raised by the tenant Caltex was highly material to the issue of net revenue and therefore the purchase price.

The Court then turned to the matter of the FTA. Section 9 of the FTA provides a broad statement that “No person shall, in trade, engage in conduct that is misleading or deceptive or is likely to mislead or deceive”.

The Court noted that the FTA specifically contemplates that misleading or deceptive conduct can be by way of act or omission and held that both the vendor company and its director had breached section 9 by acting in a misleading or deceptive way by failing to provide information that should have been disclosed.

In reaching this view the Court took a broad interpretation of “in trade”. Even though the director was not personally in trade, the Court considered that the context of the transaction satisfied the “in trade” requirement.

It was also relevant that the director was directly and actively involved in the transaction and instrumental in causing the misleading and deceptive conduct.

The Court referred to another Court of Appeal judgment which mentioned that imposing such liability on directors is for public protection and acknowledged that the trade-off was the weakening of the usual protections afforded by limited liability status of companies.

The Court held that the vendor company and the director were jointly liable for a loss of $424,371 and entered judgment accordingly.

Lessons learned

This case provides some useful reminders:

  1. Be careful what clauses you agree to and make sure you understand the scope and practical effect of all terms and conditions.
  2. If you have the benefit of a due diligence clause then ask strategic, targeted and open-ended questions.
  3. Understand that a failure to provide information can also be regarded as dishonest, misleading or deceptive under the FTA. Be careful to exercise good judgment and if in doubt seek advice.
  4. Directors can be held personal liable under the FTA (not to mention other legislation such as the Companies Act and Health and Safety at Work Act) if there is a breach of obligations under those Acts.
  5. This is another reminder that agreeing to take on a directorship role can involve significant personal risk. Anyone considering taking on a directorship should make sure they understand the duties, responsibilities and risks that come with the role. They should also have a good understanding of the company and its business.
  6. Directors should also consider:

At Gallaway Cook Allan we have experienced property and commercial teams that can successfully guide you through these types of issues. Please feel free to get in touch if you would like us to assist.

Disclaimer: this article is general in nature and not intended to be used as specific legal advice.