PROBLEM: BUSTAMONTE

Gabriel and Elena Bustamonte, a young married couple, inherited a sum of money
and wanted to use it to start or invest in a business. They went to First Fidelity, the bank
with which they had their accounts, and spoke to Beth O'Reilly, a bank officer. O’Reilly
told them that Dean's Market, a grocery store located on Main Street, was for sale. The
market was owned by Dean and Betty Feder. The Bustamontes expressed interest. O'Reilly
referred the Bustamontes to John Pieper, the business broker representing the Feders in
the transaction, and to First Fidelity's Vice-President and branch manager, D.J. Morton.

Because they had never done anything like this before, they retained Kenny, a
business broker and consultant, to assist them with the transaction. They agreed that
Kenny would counsel them in the purchase process and would provide advice on the
continuing financing and operation of the business during the first year of operation.
Kenny’s written agreement with the Bustamontes provided that he would not be liable for
any damages beyond the amount of his fee.

During a series of meetings with the Bustamontes, Kenny, and Morton, the Feders
and Pieper discussed the sales and expenses of the market's operation with the
Bustamontes. Pieper assured the Bustamontes that they could make a "good living" from
the store if they "worked hard."

They were also told that the Feders wanted to "retire from the business."

They were also told that the store had been in the Feders’ family for a long time. In
fact, the Feders had purchased the store six years earlier.

During the conversations, Gabriel Bustamonte mentioned that he thought this store
was a particularly good prospect because there was no competition in the immediate area.
Although Pieper knew that Wawa had acquired a property two blocks away with the
intention of locating a convenience store there (which it subsequently did), he did not say
anything in response. (During the past few years, Wawa stores have increasingly offered a
range of grocery items for sale.)

Pieper presented the Bustamontes with financial statements for the previous year
which showed the operating expenses and income from the store. These statements showed
such items as the cost of goods sold and receipts from sales. They did not reflect items such
as the fees for mercantile licenses, sales tax payable, or real estate tax on the building.

The statements reflected receipts and expenses on a cash basis (i.e., money received
and paid during the year). Because the Feders had ordered and paid for a large amount of
inventory at the end of the year prior to the year shown on the statements, the net receipts
of the store appeared very favorable. Kenny, the Bustamontes’ broker and consultant,
reviewed these statements and mentioned to them that he thought the expense ratio (i.e.,
the ratio of expenses to income) was low, but neither he nor they pursued the matter.

During their meetings, Pieper stated that he had done a preliminary appraisal of the
business, and he believed a fair price for the land and building was $175,000 and for the
business was $150,000. He did not explain the basis for this appraisal, and the Bustamontes
did not inquire. In fact, to determine the value of the building, he compared recent
property sales in the area, although he did not carefully consider the differences between
those buildings and the Feders’ building. To determine the value of the business, he relied
on the limited financial statements discussed in previous paragraphs.

After the initial series of meetings discussing the sale of the store, Pieper prepared
and presented to the Bustamontes an acquisition package. The acquisition package
described the terms of the proposed deal, such as the price (allocated between the building
and the assets of the business), the timing, and other matters.

The Bustamontes asked Morton if they were eligible for any loans or government
programs, particularly those designed to encourage minority business ownership. (The
Bustamontes are Latino.) Morton mentioned two programs and gave them the appropriate
literature. The first, operated by the Department of Housing and Urban Development, was
called the Minority Enterprise Program. Morton told them that they were not eligible for
participation in this program because the store was not located in a district covered by the
program. In fact, that information was incorrect. Although the Bustamontes looked at the
literature Morton provided (a detailed, twenty-four page brochure and accompanying
forms), they did not discover the error, in part because the list of eligible districts was
mentioned in the literature but only actually published in the Federal Register and on the
Department’s web site.

The second program Morton mentioned was a loan program operated by the Small
Business Administration. Morton advised the Bustamontes to obtain an SBA loan for the
purchase of the market. An SBA loan allows First Fidelity to safeguard its risk by
guaranteeing repayment of ninety percent of the loan to First Fidelity in the event of
default; because the SBA guarantees repayment, lenders are encouraged to make loans
they might not otherwise. Morton gathered the necessary information and prepared the
SBA loan application for the Bustamontes. The application included an internal bank
appraisal of the store, valuing it at $140,000 ($110,000 plus $30,000 inventory). Morton also
compiled figures for the loan application that showed the store was likely to be profitable,
based on reports from the Feders and from the grocery's food supplier, Affiliated Foods.
The Bustamontes signed the application form. The SBA loan was approved. (The purchase
of the building itself was not eligible for an SBA loan.)

Morton did not know about a third program, administered by the state, that
provided assistance to minority entrepreneurs.

First Fidelity financed the purchase price for the business ($130,000), for the land
and building ($165,000) and the beginning operating expenses (through a line of credit).

After the closing of the transaction the Feders moved to Florida, where they opened
a convenience store.

Following the purchase of the market, the Bustamontes eagerly went to work
making improvements on the store and began operations.

Within only a few months the business was in serious financial trouble. The
Bustamontes failed to earn nearly as much as the Feders had. Revenues were inadequate to
cover expenses. Over this time, First Fidelity advanced $25,000 in additional loans to the
Bustamontes. Eventually, they were put on a cash-only basis with their food supplier,
Affiliated Foods, and First Fidelity began to return the Bustamontes' checks for insufficient
funds.

To make matters worse, the Bustamontes had purchased a refrigerator and a

freezer from General Appliance, a large manufacturer. After a few weeks of use, the
refrigerator motor caught fire. The resulting fire destroyed the refrigerator. A week later,
the freezer motor also caught fire, destroying the freezer and some adjacent fixtures. Each
of these events caused the loss of a significant part of the store’s sales for a period of time.
The refrigerator and the freezer included documents stating General’s standard terms,
including a limitation of warranty to a repair or replace warranty and a disclaimer of
consequential damages.

Even worse, shortly after the Bustamontes replaced the refrigerator the store
experienced a power surge that overloaded the motor in the new refrigerator, causing it to
burn up. The power surge also caused a loss of electricity in their neighborhood so that the
store was shut down for three days with an associated loss of sales. The surge was due to
negligent installation of a transformer by Public Electric, the local electric utility.

The Bustamontes hoped that the losses from the refrigerator and freezer (including
lost sales) would be covered by insurance. When they purchased the store, they asked
Cartman, their insurance agent, to procure whatever insurance they needed for the store.
They told him that because they had never operated a business before, they did not know
what type of insurance they needed. Cartman procured a property damage policy and a
comprehensive general liability policy. However, because he believed a business
interruption policy was more expensive than the Bustamontes would want, he did not
procure that type of policy for them. The lost business they incurred from the events
described above would have been covered by the business interruption policy but was not
covered by their other policies.

With things going from bad to worse, the Bustamontes closed the store nine months
after the purchase.

First Fidelity made a demand on the SBA for payment of the ninety-percent
guarantee and turned servicing the loan over to the SBA. Upon foreclosure, SBA
determined the fair market value of the store to be $42,000, exclusive of inventory.

Recently, the Bustamontes have learned of several disquieting facts. When they had
investigated the business, they believed that the Feders were operating profitably and were
making a good living from the store. In fact, the Feders had a long-term record of poor
performance. Two months before the sale, they considered liquidation of the store’s assets,
until, fortuitously, the Bustamontes came along and expressed interest in the purchase.
 The Bustamontes also learned that the Feders had a prior relationship with First
Fidelity and learned that the business had had substantial debts which were not being paid.
As an example of the Feders= difficulties, during the four years prior to the sale they
borrowed $47,000 to cover cash shortfalls. Moreover, they were heavily indebted and were
frequently late on loan payments. At no time prior to this did anyone intimate to the
Bustamontes that the Feders held a loan with First Fidelity. Further, there was never any
indication that First Fidelity would find it desirable to have the market sold, rather than
pursuing foreclosure against the Feders, which would have resulted in piece-by-piece, less
advantageous liquidation

These facts would have been evident from an examination of the financial records of
the Feders and the store; a cautious, experienced buyer would have examined these records
prior to purchasing the store. In fact, Kenny investigated the operation of the store by the
Feders but failed to discover their financial difficulties. This failure may have been due in
part to Kenny’s inexperience in such matters. He had told the Bustamontes that he had
considerable experience in the purchase and operation of small businesses. In fact,
although he had experience in real estate transactions, he did not have much experience in
small businesses.

The Bustamontes also question whether Kenny’s inexperience lead him to give them
bad advice about the operation of the business, and, indeed, whether he may have
deliberately taken advantage of them. In particular, Kenny counseled them on how to
purchase supplies for the store and sometimes dealt with their suppliers himself. They
believed that he caused them to pay higher than normal prices for some supplies, received
undisclosed commissions and kickbacks from their suppliers, told them he had performed
certain services that he never performed, and billed them for those services.

Discussion questions

1) Evaluate the Bustamontes’ causes of action against Cartman.

2. Do the Bustamontes have a cause of action against Kenny for the issues relating to
suppliers stated in the last paragraph of the facts?

Regarding the economic loss rule:

What actions do/may the Bustamontes have against General Appliance and Public
Electric?
Assume that there is a misrepresentation action against Kenny for misrepresenting
his qualifications. Is that action barred by the economic loss rule?

Do the Bustamontes’ have causes of action against the Feders (assuming Pieper is
acting as their agent).?