AFTER YEARS OF battling, HP has recently won its civil fraud case against Autonomy founder and chief executive Mike Lynch. The ruling found that the defendants had fraudulently inflated the company’s reported revenue and value in the run up to the acquisition and must now pay compensation.
Chris Francis, Commercial Litigation Solicitor, Ashfords LLP, warns that the judgment acts as a lesson and warning for any SME considering selling or involved in a Mergers & Acquisition process.
The civil case itself was complex, and the documentary evidence spans some 28,000 documents. At the time of writing, the published judgment is awaited and a further hearing in respect of the quantum of the claim, will follow.
The case itself concerns the conduct of Mr Hussain and Mr Lynch (the Defendants) as directors of Autonomy Corporation Limited, in the run-up to the $11.1 billion acquisition of it by the Hewlett Packard Group (HP).
The court determined that the Defendants had engaged in dishonest practices designed to misrepresent the true position of the company’s affairs. The allegations included artificially generating revenue using various sham transactions and the manipulation of accounts to alter the portrayed profitability of their software. In reliance upon the published accounts and the Defendants’ various statements about those accounts, HP had been induced into spending a significant sum to purchase the business of Autonomy. The full value of their claim was advanced in the sum of circa $5 billion, albeit the judge has indicated that his final findings will represent a significant discount to that figure when he ultimately determines the level of loss.
What was clear from the judge’s summary, is that this was a sophisticated scheme under which the two Defendants were able to deliberately manipulate the company’s revenue to inflate its value and mask issues it was experiencing. That particular finding of dishonesty is not one that will ordinarily translate itself into the everyday SME company transactions however the finding that the purchaser relied upon the data in inducing them to purchase the company is. It follows that the case is one that should still serve as a warning to companies, and more particularly, their directors.
There are a great number of possible scenarios, which could arise in a sale transaction, which could expose company directors, even if acting honestly. It is conceivable that an otherwise diligent director could innocently fail to take into account a flaw in a company’s reporting processes, spot errors in accounts, or misdescribe a corporate action which could have the unintended effect of inflating corporate value. In that scenario, despite their naivety, they might face allegations that they have misled as to the true position of the company’s affairs and induced the other party into the transaction. Whether such an allegation rings true is one question, but even where liability is escaped, the allegation itself may become the source of costly, stressful and time consuming litigation which might otherwise have been avoided. Whilst this case offers perhaps an extreme example, it also goes to demonstrate the difficulties to a defendant of attributing blame to auditors, accountants or other professional advisers and reinforces the concept that ultimately ,’the buck stops’ with a company’s director(s).
It is always worth bearing in mind that the burden of proof in civil cases, such as this one, is a balance of probabilities test, or put another way, that it is more likely than not that the alleged action took place. This is in contrast to the criminal standard, that a defendant’s guilt must be beyond reasonable doubt. This lower standard opens the door for those claims that are perhaps more speculative but are nevertheless the source of considerable risk to an individual, both from a reputational and financial viewpoint.
What steps can we then take, to minimise the risk of allegations of this nature rearing their head?
- Consider the early engagement of professionals in relation to the management of accounting processes;
- Critically examine reporting processes, assumptions and ensure material issues are noted;
- Ensure that you understand the actions taken by any fellow director and if necessary seek advice or clarification on that to avoid implication by association or naivety (remember all directors are potentially liable if one of them mis-reports);
- Ensure that your instructions to representatives are comprehensive, accurate and recorded;
- Consider the instruction of professionals to oversee or manage the entirety of a transaction – a professional adviser will often ‘test’ statements made, rather than simply accepting them at face value;
- Ensure the appropriate training of staff in key business areas;
- Make disclosures where it is appropriate to do so and seek legal advice if on doubt and
- If in doubt, ask the question of your representatives for any points of concern.
Most significantly, this case underlines the importance of the accurate reporting of figures either in the build up to, or during the course of any contemplated merger and/or acquisition. The onus being on the directors to understand their business and their responsibilities – and to ensure they are reported accurately.