Seventh Circuit, Critical of Purchasing Company’s Due Diligence, Declines to Find Seller Breached of the Duty of Good Faith


On November 27, the U.S. Court of Appeals for the Seventh Circuit decided the case of Betco Corporation v. Peacock, et al., which concerns a contractual dispute between the buyer and the seller of companies that produce and market a biodegradation product that is utilized in waste management and control. After paying out the escrow contemplated by the parties’ contract, Betco Corporation (Betco) “discovered that certificates of analysis were being re‐used or falsified by the sales team.” Critical of Betco’s due diligence efforts, the Seventh Circuit held that Betco

“failed to develop its argument in the district court that its breach of contract claim was in fact a claim for intentional misrepresentation that should have survived the Agreement’s one‐year time limit. Thus, it waived this claim, and we decline to hear its merits.

However, Betco did not waive its claim against Malcolm Peacock for breach of the duty of good faith. But our only inquiry in analyzing this claim is whether Malcolm acted in a way that injured or destroyed Betco’s ability to receive the benefits of the contract. Because Betco proffered no evidence at trial of consumer complaints, it cannot show that it was deprived of its contractual expectations. To the contrary, Betco received a company producing a successful line of products to the satisfaction of its customers.”

In 2010, Betco Corporation (Betco) purchased Bio-Systems Corporation and Enviro-Zyme from Malcolm Peacock. These companies make biodegradation products containing bacteria that are designed to break down various forms of waste. Customers receive certificates of analysis which document the bacterial level in the product at the time of sale.

Before this transaction closed, representatives of Betco visited the plants, interviewed personnel and reviewed the plants’ financial data. However, after the contract was signed and Betco took over, Betco discovered that the Beloit plant was delivering defective products to its customers. Indeed, Betco learned that Bio-Systems Corporation’s sales team falsified certificates of analysis.

In April 2012, Betco sued it in Ohio federal court. The matter was then transferred to the U.S. District Court for the Western District of Wisconsin. Betco alleged fraud, negligent misrepresentation, breach of the duty of good faith and fair dealing, but the District Court denied all relief, holding that the negligent misrepresentation and breach of contract claims were time-barred by the pertinent provisions of the purchase agreement. Following a bench trail, where Wisconsin contractual law was applicable, the District Court held that Betco failed to prove that Malcolm Peacock violated any duty of good faith and had not shown any cognizable injury from the alleged violations.

On appeal, the Seventh Circuit upheld the findings and dispositions of the District Court. Under Wisconsin law, the “duty of good faith accompanies not just what the contract says but also what the parties expected to occur,” each party to a contract must not do anything which will have the effect of injuring or destroying the ability of the other party to receive the benefits of the contract. Nonetheless, the Seventh Circuit found that

“Malcolm should not have instructed the plant employees to falsify certificates of analysis and to ship product with bacteria counts too low to meet specifications. Still, Betco did not demonstrate that Malcolm’s actions at Bio‐Ohio destroyed its contractual expectations.

When Betco purchased Bio‐Systems, it expected that Bio‐Ohio would be profitable and wouldn’t face customer claims for shipping products with intentionally falsified certificates of analysis. This is what it received. Moreover, Betco did not expect that it was purchasing flawless processes.”

The Seventh Circuit was not persuaded by Betco’s argument that “it should have been permitted to introduce evidence that ‘the company it purchased was … worth far less than what Betco paid for it.” The Seventh Circuit confirmed that “the relevant inquiry for a breach of good faith is not whether Betco paid the appropriate price for the company—as it would be in an action for intentional misrepresentation or fraud—but whether Betco received the benefits that it expected when it entered into the contract.”

The Seventh Circuit suggests that if Betco’s due diligence had been more thorough, then it would not be facing the difficult problems described in this ruling. Moreover, while not condoning these actions, the Seventh Circuit also holds that the purchase agreement requires Betco to pay the defendants’ attorney’s fees and costs inasmuch as they were the prevailing party.