Virginia Business Law Update : Virginia Business Lawyers & Attorneys : PCT Law Group : Litigation Defenses, Contract Disputes, Business Formation : Northern Virginia, Arlington, Fairfax, Alexandria

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In reading the Virginia Lawyers Weekly Important Decisions of 2009, a Norfolk District Court case stood out as a reminder of the importance of a thorough due diligence examination by buyers in acquisitions of small and medium sized businesses and allocating risks in the purchase agreement. The buyer in the Norfolk case was an accountant and performed his own due diligence before his purchase of a Chesapeake accounting firm.  It is apparent from the reading of the decision, however, that the buyer did not discover all material information necessary to fully understand the target company before signing on the dotted line. Such due diligence failure and the absence of risk-shifting provisions in the purchase agreement cost him a substantial sum in the end.

The accountant in White v. Nicholas L. Potocska P.C. claimed that the Seller made misrepresentations during the negotiation of the deal which resulted in the loss of one of the firm’s largest clients after closing. Unfortunately for the buyer, his fraud claims against the Seller did not even survive to reach a jury. The Judge summarily dismissed the Buyer’s claims against the Seller based upon the accountant’s curtailment of his due diligence investigation prior to the discovery of material facts. The Court opined that the failure of the buyer to uncover certain items did not suggest fraud by the seller.

This case highlights the risks inherent in the due diligence process. In Virginia, the buyer is responsible for “every piece of paper” available to him in due diligence – even the needle in the haystack. It is interesting to note that the accountant in this case was described as “one of the most diligent prospective buyers” by a business broker who worked with him.  Perhaps the issues in this case had less to do with the accountant's "thoroughness" and more to do with the proper allocation of risks in the acquisition transaction documents.  As we often see, sometimes it isn’t practical or cost efficient to discover all potential issues in a limited amount of time.

So, how can a buyer reduce risk in an acquisition absent a lengthy, exhaustive due diligence investigation? The purchase agreement can be crafted to shift certain due diligence risks to the seller, and make clear that all parties are relying on the seller’s statements. Moreover, if client retention is a part of the purchase price to be paid to the seller, the parties can incorporate an earn-out into the purchase price formula based upon company’s revenue after the closing.