A “dog’s breakfast” is one of my favorite British expressions. It can sum up a muddled mess of confusing and contradictory allegations and purported conclusions better than almost any other idiom in the English language. And it was just this expression that Vice Chancellor Glasscock recently used to describe a cacophony of alleged extra-contractual fraud claims made by a buyer of a business against the seller of that business.
In ChyronHego Corp. v. Wight, C.A. No. 2017-0548-SG, 2018 WL 3642132 (Del. Ch. July 31, 2018), Vice Chancellor Glasscock granted the seller’s motion to dismiss as to each and every one of the claims that comprised the buyer’s “dog’s breakfast of extra-contractual fraud claims” against the seller. Vice Chancellor Glasscock did so based upon the presence of a disclaimer of reliance made by the buyer in the stock purchase agreement. Forced as a result to rely solely upon the contractual representations specifically set forth in the stock purchase agreement, the buyer then alleged that all of the extra-contractual fraud claims actually constituted the breach of a specific contractual representation whereby the seller had represented that, since the balance sheet date, the purchased company had “conducted its business in all material respects in the ordinary course of business consistent with past practice.” How so? Because, said the buyer, making an extra-contractual misrepresentation during the negotiation of the stock purchase agreement was the antithesis of conducting business in the ordinary course. But Vice Chancellor Glasscock rejected this effort to “bootstrap” the extra-contractual claims on to the contractual claims.
Just a week earlier, in Flowshare, LLC v. GeoResults, Inc., C.A. No. N17C-07-227 EMD CCLD (Del. Super. July 25, 2018), Judge Davis of the Delaware Superior Court specifically rejected a motion to dismiss a claim of extra-contractual fraud by the seller of a business against the buyer of that business based upon an alleged pre-contractual promise made by the owner of the buyer that he personally would cover any shortfall in the purchase price payable to the seller; i.e. that he would be “personally on the hook for these obligations, in addition to the companies [he] own[s].” There was no specific contractual representation contained in the asset purchase agreement to this effect, and the buyer’s owner was not an individual signatory to the asset purchase agreement. So, why was the extra-contractual fraud claim not dismissed in this case? Because there was no disclaimer of reliance clause to point to in the asset purchase agreement. Instead, all that the defendant could point to here was a standard integration clause.
Delaware law is clear that one of the elements of any fraud-based claim is “reasonable reliance” by the claimant upon the alleged representation made by the defendant. While it may be possible in any case for a defendant to prove (after discovery and a trial) that the plaintiff could not have reasonably relied upon any alleged extra-contractual representation, a clearly drafted and properly placed non-reliance clause ensures that extra-contractual fraud claims are dead on arrival (and permit their dismissal at the pleading stage of a case without the necessity of discovery or a trial). That is so because Delaware law consistently holds that, in the face of an anti-reliance clause, a complaining party alleging an extra-contractual representation “cannot, in light of the contractual provision, have reasonably relied on the prior false statements.”1 Thus, in Delaware, “where parties in language that is clear provide that they will eschew reliance on any facts but those recited, they will be held to that representation, notwithstanding prior knowingly false statements made by one party to the other.”2 But “where the contract is ambiguous, or where it merely recites that the parties meant to integrate all their prior dealing into its terms, that contract does not preclude a party’s proof of extra-contractual fraud.”3
These basic lessons in the benefits of clearly stated4 and properly placed5 anti-reliance clauses to defeat an effort by a disappointed counterparty to expand the express factual predicates to a deal, which were incorporated into a fully negotiated and signed written agreement, seem to continue to need to be relearned over and over again. And these lessons are particularly important to private equity sellers intent on prompt distribution of sales proceeds following the closing of a transaction. But the lessons from these recent cases do not end at the importance of an anti-reliance clause as distinct from a mere integration clause. Among the other lessons worth emphasizing are the following:
Delaware public policy does not permit the enforcement of a contractual provision that “purports to limit the [s]eller’s exposure for its own conscious participation in the communication of lies to the [b]uyer” in the written agreement itself. Thus, if a fraud claim is based on statements of purported fact set forth in the written agreement (rather than extra-contractual statements) and “the [s]eller knew that the [portfolio] [c]ompany’s contractual representations and warranties were false” or “the [s]eller itself lied to the [b]uyer about a contractual representation and warranty,” then the remedies available for any such purported fraud cannot be contractually limited solely to the agreed indemnification regime. In other words, contractual provisions that purport to limit fraud claims premised upon representations contained within the agreement itself, which the seller knows to be false, whether it or the portfolio company is the actual speaker, are presumptively ineffective. But, it is perfectly permissible for parties to contractually “allocate the risk of intentional lies by the [portfolio] [c]ompany’s managers to the [b]uyer,” where the seller was unaware of such lies, as well as to contractually allocate to the buyer the risk of “reckless, grossly negligent, negligent, or innocent misrepresentations of fact” by the seller or the portfolio company.9
And note that this judicially created carve-out that permits fraud claims premised on written representations applies not only to the person making the representation but also to anyone who permits the representation to be made by an entity it controls, or on whose behalf he or she is acting, knowing it to be false when made.10 And that particular nuance was present in the claims that were made against the controlling shareholder in the ChyronHego case respecting written representations made not by the controlling shareholder but by the company being sold.
While there are those who persist in feigning ignorance of the market’s movement to define and limit fraud claims so that extra-contractual fraud is clearly eliminated by non-reliance clauses and fraud-based claims based upon the written representations are expressly limited to carve-outs that only expose the party (ies) deliberately participating in the conveyance of knowing falsehoods concerning those written representations, don’t allow that feigned ignorance to permit a counterparty to dump a dog’s breakfast of fraud claims on you after the deal closes. After all, a dog’s breakfast is not only a disgusting, muddled mess, it may interfere with the orderly distribution of sales proceeds to your limited partners and stockholders.
ChyronHego Corp., 2018 WL 3642132, at *1.
For a good example of non-reliance clause see Glenn West, Reps and Warranties Redux—A New English Case, An Old Debate Regarding a Distinction With or Without a Difference, Weil Insights, Weil’s Global Private Equity Watch, August 2, 2016, https://goo.gl/WW9oJ4
For a discussion of the proper placement of a non-reliance clause see Glenn West, The Surprising Connection Between an Extra-Contractual Fraud Claim and a Flesh-Eating Zombie, Weil Insights, Weil’s Global Private Equity Watch, March 3, 2016, http://goo.gl/AZ8bzE
TrueBlue, Inc. v. Leeds Equity Partners IV, LP, C.A. No. N14C-12-112 WCC CCLD, 2015 WL 5968726 (Del. Super. Sept. 25, 2015), discussed in Glenn West, Promissory Fraud, Anti-reliance and the Dreaded “Undefined” Fraud Carve-out, Weil Insights, Weil’s Global Private Equity Watch, October 26, 2015, http://goo.gl/UUps5d
Haney v. Blackhawk Network Holdings, Inc., C.A. No. 10851–VCN, 2016 WL 769595 (Del. Ch. Feb. 26, 2016), discussed in Glenn West, Private Equity Sellers Must View “Fraud Carve-outs” with a Gimlet-Eye, Weil Insights, Weil’s Global Private Equity Watch, March 16, 2016, http://goo.gl/uO6lfQ
Glenn West, A New Reason for Private Equity Sellers to Hate Undefined “Fraud Carve-outs,” Weil Insights, Weil’s Global Private Equity Watch, May 16, 2017, https://goo.gl/2MhPmJ
See Glenn West, Protecting the Private Equity Firm and its Deal Professionals from the Obligations of its Acquisition Vehicles and Portfolio Companies, Weil Insights, Weil’s Global Private Equity Watch, May 23, 2016, http://goo.gl/avmaA0
See generally Glenn D. West, That Pesky Little Thing Called Fraud: An Examination of Buyers’ Insistence Upon (and Sellers’ Too Ready Acceptance of) Undefined “Fraud Carve-Outs” in Acquisition Agreements, 69 Bus. Law. 1049 (2014).
See EMSI Acquisition, Inc. v. Contrarian Funds, LLC, C.A. No. 12648-VCS, 2017 WL 1732369 (Del. Ch. May 3, 2017), discussed in Glenn West, A New Reason for Private Equity Sellers to Hate Undefined “Fraud Carve-outs,” Weil Insights, Weil’s Global Private Equity Watch, May 16, 2017, https://goo.gl/2MhPmJ
See ChyronHego Corp., 2018 WL 3642132, at *6; see also Prairie Capital III, L.P. v. Double E Holdings Corp, 132 A.3d 35, 55 (Del. Ch. 2015), discussed in Glenn West, Exclusive Remedy Provisions, Fraud Carve-outs, and Personal Liability for Sell-Side Private Equity Professionals, Weil Insights, Weil’s Global Private Equity Watch, December 1, 2015, http://goo.gl/bMSl3Z
People by Schneiderman v. Credit Suisse Sec. (USA) LLC, No.40, 2018 WL 2899299, at *9 n.4 (N.Y. June 12, 2018).