In early January, 2022, American hi-tech entrepreneur Elizabeth Holmes was convicted of a series of criminal offenses related to investor fraud in the startup company she had initiated and run for years, and which, under her leadership, raised hundreds of millions of dollars. The Holmes affair is still to fill many pages of text but one interesting issue we would like to discuss here, at what stage do ambitious presentations designed to bring investors cross the line and become a criminal misrepresentation?
For example, in a case that reached the Israeli Supreme Court in 2019, a Cypriot company raised money from Israeli investors for a number of real estate projects in Eastern Europe, including a construction project of about 410 housing units in the Latvian capital Riga. The project failed, the investors lost their money and they demanded compensation for relying on the presentations made to them. The Court dismissed the claim and held that a false representation is a representation regarding reality that is inconsistent with the actual reality, even if it was presented negligently and even if it was presented without intent to mislead. It may refer to present or past facts, but a representation about the future is clearly something that is not a commitment.
But is every representation about the future immune from being deemed a false representation? Here the Courts in Israel have held that as far as a statement regarding the future is concerned, it may be considered a false representation if the person who made the representation about his future obligation did not intend to fulfill it in the first place. Thus, for example, the Supreme Court of Israel in 1997 rejected a claim of misrepresentation in a prospectus, with the prospectus recording an intent to merge the company with another company within three months, and found that the statement was a statement of intent and not a representation of fact. In order to show to a false presentation that gives rise to a cause of action of misrepresentation and fraud, the Court held, it must be shown that the representator did not intend to keep the promise made when given, and that this false promise was intended to motivate the other to act upon it.
Thus, a startup company that raises money and declares about its intentions and the potential of its technology, or even a company that goes public on the stock exchange and lists its future intentions in a prospectus, is not considered one that defrauds investors if the future predictions do not materialize or if it later changes its intents, unless at the time that the representations were made it had no intention of complying with the statements about the future or, we would even go one step further, if it had known at that stage that there was no chance that these future predictions would be met.
While investors reviewing representations need to understand that any representation regarding the future is not binding, naturally a company that makes representations to investors must ensure that all representations are accurate, whether representations about the past, or representations about the company’s future intentions. The line between such is not always clear because representations about a product or a technology, for example, may be binding representations - if such deal with the product's capabilities at the time of the representation or things about which it is already known at that stage that they will not materialize. For this reason, it is very important that any representation that is given is well checked. Thus, for example, when we are currently accompanying an IPO of the Israeli startup company Maris-Tech Ltd. on NASDAQ, every word that appears in the prospectus has been scrutinized from both the business, accounting and legal side, both under Israeli law and under New York law. Regardless of the legal exposure to future claims, inaccurate representations also undermine the company's credibility and its ability to raise funds in the future and especially in a start-up company, can have a material impact on the company's life.