UK High Court rejects aggregated knowledge as basis for fraud

The case arose from Johnson Matthey's sale of its health business to Veranova, following which claims were brought for fraudulent breach of warranties under a share purchase agreement (SPA). The claims ultimately failed, as the buyer was unable to prove fraud against any of the four executives involved.

The decision will have a significant impact going forward after underlining the rejection of the idea of ‘composite’ or ‘aggregated’ fraud, and will become a leading authority on corporate attribution and fraud in an M&A context.

How the case unfolded

Veranova, a funding vehicle by US healthcare investors Altaris, had claimed a fraudulent breach of a warranty within their SPA to buy the health business of chemicals group Johnson Matthey in May 2022.

But despite the court finding that a breach had occurred because Johnson Matthey had not disclosed information relating to a key contract being renegotiated, it found that Veranova had failed to establish fraud had taken place.

Under the terms of the sale, which was signed on 16 December 2021 and completed on 31 May 2022, the SPA contained a warranty over renegotiation of contracts which could adversely affect the health business.

The court found that the sellers had not adequately disclosed they were renegotiating a supply agreement with Alvogen under a price match clause, following an offer to Alvogen in the October by another manufacturer for a price around half of what the Johnson Matthey health business was currently charging.

In its disclosure letter, Johnson Matthey had referenced “increased competition” in the industry that had “adversely impacted, and continues to adversely impact, the Businesses' market share”, and noted that pricing discussions were under way - but the court rejected the claim that this represented sufficient disclosure under the SPA.

The SPA precluded breach of warranty claims except where they arose from either the fraud or wilful misconduct of the sellers.

Veranova sought to establish fraud by arguing that the knowledge of four Johnson Matthey executives should be aggregated, such that fraud could be attributed to the sellers even though no individual executive possessed all the relevant knowledge.

The court rejected that approach. It held that fraud required conscious dishonesty on the part of an identifiable individual. To establish fraud, it was necessary to show that a particular executive knew about the renegotiation, understood the relevant warranty and appreciated that the warranty had been breached. Those elements could not be assembled by combining the knowledge of different individuals.

The court found that the four executives did not have sufficient knowledge of the situation, nor did they display reckless behaviour which would qualify as fraud, describing them as “improbable targets” for the charge.

The court also said that failing to check the disclosures was not the same as a conscious awareness that the disclosures may be insufficient, pointing out that the health business was the smallest part of Johnson Matthey’s business and that the executives would also be busy with other duties and responsibilities, thus relying on a disclosure process run by the company’s legal and business representatives.

What the decision means

The most important aspect of the decision is its clear rejection of 'aggregated knowledge' as a route to establishing fraud. The court reaffirmed that fraud requires conscious dishonesty on the part of an identifiable individual and cannot be inferred simply because different people within an organisation knew different parts of the story. The judgment also reinforces the distinction between fraud and negligence – highlighting that errors in process, oversights and poor judgment do not, without more, amount to fraud.

While the court found that the key contracts warranty had been breached because the offer from the other manufacturer and its implications were not fairly disclosed, the fraud claim nevertheless failed – illustrating that establishing a warranty breach is fundamentally different from proving a fraudulent breach of warranty.

The case also serves as a reminder that general references to pricing pressure, increased competition and ongoing customer discussions are also insufficient when specific developments could have a material impact on the business. Such matters should be disclosed clearly and expressly.

How does this impact you?

For buyers and sellers alike, the Veranova case is likely to become an important authority on fraud carve-outs, disclosure obligations and corporate attribution in M&A transactions.

It reinforces that fraud remains a high threshold and cannot be established merely by identifying process failures or piecing together knowledge held by different individuals within a business.

The judgment also underlines the value of a robust disclosure process. The existence of a structured disclosure exercise involving management, internal legal teams and external advisers was a significant factor in defeating the fraud allegations.

Sellers should take from the decision the importance of ensuring that disclosure exercises are fully documented and involve all relevant individuals, and should specifically disclose material commercial developments rather than just relying on general disclosures. Any significant developments which arise close to signing a deal should be escalated for assessment for disclosure to prevent unnecessary challenges after the fact.

Those on the buyers’ side should make sure they probe any underlying causes of a decline in trading performance by their target, rather than relying on generic disclosures. Particular attention should be paid to whether adverse developments arise from general market conditions or from specific events that may require targeted inquiry and disclosure.

Co-written by Sanita Heer of Pinsent Masons