Seeking deal costs after fraud found in diligence?

March 22, 2023

by a searcher in Dallas, TX, USA

I recently had a deal that we discovered fraud and large hidden liabilities during due diligence towards the end of the finish line. The deal is not going to be able be underwritten with potential liabilities being worth more than enterprise value. Do we have a right to go after the seller and investment banker for dead deal costs?

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Reply by a searcher
from Tufts University in Jersey City, NJ, USA

We backed out of an LOI once due to seller misrepresentation that arguably constituted fraud (the IRS also would've loved to take a look at those books). We walked away happily and saw the sunk cost as being significantly smaller than the cost of what would've happened if we hadn't done our due diligence and ended up closing a bad deal. It's not fun to eat the loss, but as others have pointed out, usually the only people who end up ahead in small lawsuits are the lawyers. This is also a good reason for why you should front-run as much of the non-professional due diligence before engaging with your third party checkpoints. Internal DD comes first, then the accountant, lawyers are always last. Don't spend money drafting and negotiating final docs unless you're already green-lit on diligence. You're still out accounting cost if you catch issues in QofE, but taking things stepwise reduces your exposure.

Reply by an intermediary
from Wesleyan University in Granville, OH, USA

I'm in line with ^redacted‌ and ^redacted‌. It's worth noting that deals fall apart all the time for all kinds of reasons. Unless you have a breakup fee in the LOI, which is very unusual in deals that don't start with a B, it's considered the cost of doing business. I've not seen outright fraud, but definitely some questionable ethical behavior that tied up counterparties for months and scuttled deals. Unless the cost is existential in some way (beyond the cost of diligence resources), it's usually a better idea to swallow the bitter pill and move on.

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