FORTUNE — Private equity firm OpenGate Capital is suing lab equipment giant Thermo Fisher Scientific (TMO), claiming that it was duped into buying a business whose primary manufacturing facility had been overrun by a Mexican drug cartel.
It is a bizarre case, and basically will ask a Los Angeles court to determine where deficient due diligence ends and fraudulent disposal begins. Buyer beware or seller be guilty.
The deal in question occurred late last year, when OpenGate agreed to buy Thermo Fisher’s workstations business (now known as Hamilton Scientific) for approximately $13 million.
Thermo Fisher had announced it was putting Hamilton Scientific for sale in a June 28, 2012 regulatory filing, adding that the business had generated $180 million in 2011 revenue and that the planned divestiture would result in around a $50 million after-tax loss. Investment bank Barclays (BCS) was soon hired to manage the process, which OpenGate claims was to be done “as fast as possible, and, eventually, regardless of purchase price.”
OpenGate first expressed interest in Hamilton Scientific on July 2, and entered into preliminary due diligence. By August, however, OpenGate says that the “information flow stopped” because Thermo Fisher “had engaged another buyer who ultimately backed out.” In mid-September, Barclays reconnected with OpenGate.
Get it closed
This is where the complaint’s narrative begins to get strange. OpenGate claims that Thermo Fisher responded with “acrimony” to requests for information, and that “the information produced changed with each question.” Moreover, Thermo Fisher allegedly was pushing to have the deal close as fast as possible, refusing to accept “satisfactory completion of due diligence” as a closing condition. Talks became increasingly tense, but ultimately OpenGate believed it had received enough information to sign a purchase agreement on October 5 “without a provision for unwinding the deal in the event of any post-execution discoveries.”
Soon thereafter, Thermo Fisher allegedly “dumped a series of material documents… reflecting additional liabilities to be guaranteed by [OpenGate]” but “by that time, the Purchase Agreement was effective and [OpenGate] had no recourse.” The deal formally closed on October 25, with OpenGate paying $13 million and Thermo Fisher retaining a 10% equity stake in the business.
The next day, OpenGate representatives arrived in Reynosa, Mexico to conduct town hall meetings with employees at Hamilton Scientific’s primary manufacturing facility. One employee told OpenGate that members of the Gulf Cartel — one of Mexico’s most notorious drug trafficking gangs — regularly entered appeared at the facility’s perimeter and sometimes even entered the main building itself. The employee also asked that OpenGate increase facility security.
What did we buy?
OpenGate claims to have immediately begun to investigate the situation, and learned that Gulf Cartel incursions occurred “every day,” with members having been known to brandish weapons at employees in order to gain parking lot access (at times, they allegedly left “tractor-trailers filled with unknown cargo” overnight). It also learned that on Sept. 23, 2012 — in the middle of deal negotiations — “armed militants entered the cafeteria at the Reynosa Facility after being followed by rivals (either opposing cartel members or soldiers). They stayed for an hour or more before leaving.”
Most importantly, OpenGate claims that Thermo Fisher was aware of the situation and deliberately hid it from the private equity firm during due diligence. For example, when Hamilton Scientific’s HR head for Mexico told his boss at Thermo Fisher about some violent activity at the facility, he replied via email that “I believe we are through the diligence process with our buyers, so don’t know that now is the time to raise the issue.”
The lawsuit requests unspecified damages for fraud, breach of contract and securities laws violations.
Warning signs
What the lawsuit doesn’t adequately explain, however, is why OpenGate moved forward with the deal in the first place. After all, there were enough red flags to fill a Chinese sports stadium.
For starters, why was Thermo Fisher willing to sacrifice price for speed? It’s not as if the $30 billion business was desperate for $13 million. And why would Thermo Fisher not allow OpenGate to speak with floor employees at the Reynosa facility? And why, when OpenGate did make its due diligence visit, was it driven in and out of the facility via van by Thermo Fisher representatives (at a time when OpenGate now believes the Gulf Cartel was known not to be present)?
Obviously I’m not suggesting that OpenGate should have asked if there was a drug cartel operating out of a Hamilton Scientific facility, but it should have been worried that it had no opportunity to ask open-ended questions to the rank-and-file. Seems like pretty shoddy private equity work.
So ultimately the case will hinge on two things: (1) Did Thermo Fisher intentionally deceive OpenGate, and/or (2) Was the undisclosed information material to Hamilton Scientific.
It’s possible that latter question will be partially informed by how much OpenGate has subsequently spent on security upgrades and if it ultimately opts to relocate the facility (a conversation which I hear is ongoing).
For its part, Thermo Fisher provided the following statement:
“We believe this lawsuit is without merit. The safety and security of our work sites and employees is always our first priority. We are confident that our facilities are compliant with all local laws and regulations, and operated Reynosa consistent with that commitment during our ownership of the facility. We ran a comprehensive auction process for the Laboratory Workstations business that allowed potential buyers to conduct thorough due diligence, giving them access to all information and providing ample opportunity for site visits to each of those facilities.”
Thermo Fisher would not respond to follow-up questions about Gulf Cartel activity at the Reynosa facility, which is not referenced in its statement.
OpenGate Capital declined to comment, as did Barclays (which is not named as a defendant).
The full complaint is posted below:
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