In the last few months, the Delaware Court of Chancery has issued two opinions addressing fraud claims in connection with private M&A transactions based upon representations and statements made by sellers outside the four corners of the acquisition agreement, with quite different results for the allegedly defrauded buyers.

In Prairie Capital III, L.P. v. Double E Holding Corp.1 (Prairie Capital), decided in November 2015, the Court granted a motion to dismiss fraud claims brought by the buyer in the purchase of a private business to the extent that the claims were grounded on false representations made outside of the purchase agreement. The Court found that the extra-contractual fraud claims were barred by an “exclusive representation clause” in which the buyer affirmatively acknowledged that it relied only on the representations and warranties in the purchase agreement.

In the second case, FdG Logistics LLC v. A&R Logistics Holdings, Inc.2 (FdG Logistics), decided a few months later, the Court allowed fraud claims based on statements and omissions in a confidential information memorandum, a management presentation, and other due diligence materials, despite the fact that the merger agreement governing the transaction contained a clear disclaimer from the sellers stating that the sellers were not making any representation or warranty outside of the merger agreement. In the court’s view a disclaimer from the sellers was not sufficient. The buyer, as the aggrieved party, must acknowledge its non-reliance on information provided outside the scope of the agreement to preclude fraud claims for extra-contractual statements.

Prairie Capital III, L.P. v. Double E Holding Corp.

Prairie involved the sale of Double E Parent LLC (Double E) to Double E Holding Corp. (the Double E Buyer), an acquisition vehicle owned by a private equity firm, Incline Equity Partners, III L.P. (the Incline Fund). The principal sellers were two private equity funds that owned a controlling interest in Double E (the Double E Sellers), which were sponsored by Prairie Capital Partners (Prairie Capital). The sale was made pursuant to a stock purchase agreement, which was signed April 4, 2012 (the Stock Purchase Agreement), and the transaction was completed the same day. One of Prairie Capital’s affiliated funds served as the representative of the Double E Sellers under the Stock Purchase Agreement (the Seller’s Representative). The parties agreed that a portion of the purchase price would be held in escrow until June 30, 2013, to cover potential indemnity claims brought by the Double E Buyer.

Two days before the escrowed funds were scheduled to be released; the Double E Buyer submitted an indemnification claim notice asserting, among other claims, that Double E and its management had engaged in fraud with respect to financial statements that the Double E Buyer had relied on in its decision to pursue the transaction.

In September 2014, the Sellers’ Representative sued the Double E Buyer to compel the release of the escrowed funds. The Double E Buyer and the Incline Fund asserted counterclaims against Prairie Capital and two former officers of Double E for fraud, aiding and abetting fraud, and conspiracy to commit fraud, as well as contractual claims for indemnification under the Stock Purchase Agreement.

The counterclaims brought by the Double E Buyer and the Incline Fund alleged that the fraudulent actions began in the summer of 2011 at the time Double E was first being marketed for sale, when Double E’s management, under pressure to support a growth story being pitched to potential buyers, began to falsify Double E’s financial statements.

In its analysis of the counterclaims brought by the Double E Buyer and the Incline Fund, the Court noted that to plead fraud, a plaintiff must identify a false representation. The counterclaims relied on four allegedly false representations made in the Stock Purchase Agreement, as well as on purportedly false representations made in writing and orally during the sale process and due diligence that did not appear in the Stock Purchase Agreement.

The Court found that the Stock Purchase Agreement foreclosed fraud claims based on misrepresentations made outside of the agreement. The Stock Purchase Agreement contained the following “Exclusive Representations Clause”:

“The Buyer acknowledges that it has conducted to its satisfaction an independent investigation of the financial condition, operations, assets, liabilities and properties of the Double E Companies. In making its determination to proceed with the Transaction, the Buyer has relied on (a) the results of its own independent investigation and (b) the representations and warranties of the Double E Parties expressly and specifically set forth in this Agreement, including the Schedules. SUCH REPRESENTATIONS AND WARRANTIES BY THE DOUBLE E PARTIES CONSTITUTE THE SOLE AND EXCLUSIVE REPRESENTATIONS AND WARRANTIES OF THE DOUBLE E PARTIES TO THE BUYER IN CONNECTION WITH THE TRANSACTION, AND THE BUYER UNDERSTANDS, ACKNOWLEDGES, AND AGREES THAT ALL OTHER REPRESENTATIONS AND WARRANTIES OF ANY KIND OR NATURE EXPRESS OR IMPLIED (INCLUDING, BUT NOT LIMITED TO, ANY RELATING TO THE FUTURE OR HISTORICAL FINANCIAL CONDITION, RESULTS OF OPERATIONS, ASSETS OR LIABILITIES OR PROSPECTS OF DOUBLE E AND THE SUBSIDIARIES) ARE SPECIFICALLY DISCLAIMED BY THE DOUBLE E PARTIES.”3

The Stock Purchase Agreement also included a standard integration clause stating that the agreement set forth the entire understanding of the parties with respect to the transaction and that it superseded all prior discussions of the parties.

The Incline Fund argued that the Stock Purchase Agreement should not foreclose its extra-contractual fraud claims, because it failed to specifically state that the Double E Buyer did not rely on representations other than those made in the Stock Purchase Agreement. The Incline Fund looked to Delaware case law requiring that anti-reliance representations must be explicit and clear.

The Court, however, noted that “Delaware law does not require magic words.”4 Rather than stating that the Double E Buyer did not rely on representations outside of the agreement, the Stock Purchase Agreement stated that the Double E Buyer only relied on the representations and warranties in the Stock Purchase Agreement. The Court stated: “If a party represents that it only relied on particular information, then that statement establishes the universe of information on which that party relied. . . . In this case, the Exclusive Representations Clause and the Integration Clause combine to mean that the [Double E] Buyer did not rely on other information. They add up to a clear anti-reliance clause.”5

The court dismissed the fraud counterclaims to the extent based on extra-contractual representations, but it found that the counterclaims adequately plead that three of the representations in the Stock Purchase Agreement were false when made.

FdG Logistics LLC v. A&R Logistics Holdings, Inc.

This case arose out of the acquisition of a trucking company, A&R Logistics Holdings, Inc. (A&R) in 2012. A&R was acquired by Mason Wells, a private equity fund, through a merger transaction in which a subsidiary of Mason Wells was merged into A&R, with A&R as the surviving entity. (A&R as the surviving entity is referred to in the opinion as the Buyer). Prior to the merger, FdG Associates LP, a New York private equity firm, (FdG) owned 62.15 percent of A&R’s outstanding shares. (FdG and its affiliates and A&R’s other shareholders prior to the merger are referred to in the opinion as Securityholders).

In 2012, A&R’s board began an auction process to sell the company and engaged an investment company and a financial advisor to assist with the sale. A lengthy confidential information memorandum describing A&R’s business was prepared, which touted A&R’s market leadership and the quality of its fleet of trucks. During the sale process, the Buyer’s representatives met with A&R’s management and received a power point presentation, which also emphasized the quality of A&R’s trucks and equipment. In addition, prior to the merger, the Buyer’s team had access to an online data room with due diligence information about A&R. Once the Buyer’s representatives and A&R signed a letter of intent, the parties began preparing definitive documents for the transaction. The acquisition was completed pursuant to a merger agreement (the Merger Agreement) on Dec. 18, 2012.

Within six months after the merger closed, the Buyer began asserting indemnification claims against the Securityholders. The Securityholders’ representative brought an action in the Delaware Chancery Court to recover a pre-closing tax refund. The Buyer asserted counterclaims alleging that A&R had engaged in illegal and improper activities that were concealed from the Buyer during the due diligence process, such as falsifying driver records, breaching environmental laws, improperly recording expenses, fraudulently charging customers for services that were not performed and hiring aliens who were not authorized to work in the U.S. The Buyer’s fraud claims were based, in part, on documents provided to the Buyer during the due diligence process, including the confidential information memorandum and the management power point presentation.

The Securityholders argued that the Buyer could not establish as a matter of law that it justifiably relied on any representations in any pre-merger materials because the Merger Agreement contained an anti-reliance clause. In the article of the Merger Agreement with A&R’s representations and warranties, the agreement contained the following statement from A&R:

“EXCEPT AS EXPRESSLY SET FORTH IN THIS ARTICLE 5, THE COMPANY MAKES NO REPRESENTATION OR WARRANTY, EXPRESS OR IMPLIED, AT LAW OR IN EQUITY AND ANY SUCH OTHER REPRESENTATIONS OR WARRANTIES ARE HEREBY EXPRESSLY DISCLAIMED INCLUDING ANY IMPLIED REPRESENTATION OR WARRANTY AS TO CONDITION, MERCHANTABILITY, SUITABILITY OR FITNESS FOR A PARTICULAR PURPOSE. NOTWITHSTANDING ANYTHING TO THE CONTRARY, (A) THE COMPANY SHALL NOT BE DEEMED TO MAKE TO BUYER ANY REPRESENTATION OR WARRANTY OTHER THAN AS EXPRESSLY MADE BY THE COMPANY IN THIS AGREEMENT AND (B) THE COMPANY MAKES NO REPRESENTATION OR WARRANTY TO BUYER WITH RESPECT TO (I) ANY PROJECTIONS, ESTIMATES OR BUDGETS HERETOFORE DELIVERED TO OR MADE AVAILABLE TO BUYER OR ITS COUNSEL, ACCOUNTANTS OR ADVISORS OF FUTURE REVENUES, EXPENSES OR EXPENDITURES OR FUTURE FINANCIAL RESULTS OF OPERATIONS OF THE COMPANY UNLESS ALSO EXPRESSLY INCLUDED IN THE REPRESENTATIONS AND WARRANTIES CONTAINED IN THIS ARTICLE 5, OR (II) EXCEPT AS EXPRESSLY COVERED BY A REPRESENTATION AND WARRANTY CONTAINED IN THIS ARTICLE 5, ANY OTHER INFORMATION OR DOCUMENTS (FINANCIAL OR OTHERWISE) MADE AVAILABLE TO BUYER OR ITS COUNSEL, ACCOUNTANTS OR ADVISORS WITH RESPECT TO THE COMPANY.”6

The Merger Agreement also included a standard integration clause that provided that the Merger Agreement contained the entire agreement of the parties and superseded any prior understandings, agreements, or representations of the parties.

The Court noted that Delaware law enforces anti-reliance clauses and discussed the seminal case on the matter, Abry Partners V, L.P. v. F & W Acquisition LLC,7 in which then Vice Chancellor Strine “carefully considered the need to strike an appropriate balance between holding sophisticated parties to the terms of their contracts and simultaneously protecting against the abuses of fraud.”8 The Court then reviewed recent case law in the area, including the Prairie decision, focusing on one key difference between the anti-reliance clause in Prairie and the clause in the A&R Merger Agreement. In Prairie, the allegedly defrauded party had specifically represented that it was relying only on the representations in the agreement. In FdG Logistics, on the other hand, the Securityholders, the parties who were accused of the fraudulent actions, had disclaimed any representations made outside of the Merger Agreement, but the Buyer had not specifically stated that it was relying only on representations made in the Merger Agreement, or disclaimed reliance on representations made outside the Merger Agreement. The Court acknowledged that this subtle difference “between a disclaimer from the point of view of a party accused of fraud and from the point of view of a counterparty who believes it has been defrauded may seem inconsequential, like two sides of the same coin. The difference is critical, however, because of the strong public policy against fraud.”9 Asserting that an affirmative disclaimer from the point of view of the Buyer was the missing piece in this case, the Court denied the Securityholders’ motion to dismiss the Buyer’s fraud claims.10

Anti-Reliance Clauses You Can Rely On

It is not surprising that sellers want to limit their exposure for information provided to potential buyers during the sale process. Sellers and their advisors seek to put their best foot forward in presentations to potential buyers and may be prone to puffery and exaggeration at times. Senior managers, seeking to please their future bosses, may be motivated to stretch the truth regarding their performance. In the interest of disclosure and sometimes just the sheer rush and exhaustion of closing a deal, documents are dumped into online data rooms, occasionally without careful checking of the content. Without an anti-reliance clause, a misstatement in a management presentation or in sales figures buried in a sub-folder of the data room could come back to haunt sellers who had no intention of committing fraud. On the other hand, as a practical matter, buyers often rely on these materials for their decision making far more than the disclosure schedules attached to the acquisition agreement, which are often delegated to a junior legal associate, with the buyer’s team giving them a once over just before closing. One way to address this is to specifically identify key information on which the buyer is relying and attach this to the acquisition agreement. This is usually the case with financial statements, but other materials, such as interim sales figures, environmental assessments or management reports, can also be specifically referenced in the representations or attached to the agreement if they contain information that is key to the Buyer’s purchase decision. Once the relevant information is specifically identified, sellers should include an express anti-reliance clause in the sale agreement. As noted in Prairie, this clause does not need to contain any magic words, but it should be express and specific and, critically, it should come from the buyer. As the Court noted in Abry Partners, the subtle difference between disclaimer clauses can make all the difference in a fraud action.