Acquisition agreements frequently contain maximum limits or “caps” on the sellers’ potential liability for losses resulting from breaches of the sellers’ and target company’s representations and warranties. However, the indemnification provisions frequently provide carve-outs from the cap for fraud or intentional breach of the representations.

A recent Delaware Chancery Court decision, EMSI Acquisition, Inc. v. Contrarian Funds,1 highlights a potential trap for the unwary selling shareholder wherein the target management may be engaged in fraudulent activity without the selling shareholder’s knowledge.

Established Delaware M&A law, following the landmark opinion in Abry Partners V, L.P. v. F&W Acquisition, LLC,2 provides that the exclusive remedy provision in an acquisition agreement limiting the buyer’s recovery from the seller to the indemnification provision of the purchase agreement will not defeat a fraud-based claim for rescission or damages where the “seller acted within an illicit state of mind, in the sense the seller knew” that the seller’s or target company’s representations and warranties were false.

EMSI, relying on Abry, found that the fraud exception contained in the exclusive remedy provision of the acquisition agreement may be construed to relieve the buyer from the cap on indemnification claims against an innocent seller if the facts giving rise to the breach of the company’s representation involved management’s fraud.3

EMSI highlights the need for sellers and their counsel to specifically consider, and if appropriate, unambiguously provide that no fraud exception will apply to the cap on an indemnification claim against a seller unless the individual seller consciously knew the representation was false and acted with an illicit state of mind.