The U.S. District Court for the Southern District of New York held that a seller could maintain actions for fraud and fraudulent inducement based on a purchaser’s alleged representation of the meaning of contractual terms during negotiations. FPP, LLC v. Xasis US, LLC, 14cv6172, (U.S. Dist. S.D.N.Y.). The seller had a software and video advertising technology business. In 2011, the purchaser acquired the seller’s business under an Asset Purchase Agreement ("APA"), which included both a cash payment and a potential earn-out payment. Ultimately, a dispute arose concerning how much the seller earned under the earn-out provision. The seller alleged the purchaser did not calculate the earn-out correctly and brought claims for breach of contract and, in the alternative, fraud and fraudulent inducement.
In its fraud claim, the seller alleged that it rejected the purchaser’s original earn-out definition and stated that the definition had to reflect "actual revenue." After further negotiations, the purchaser was tasked with modifying the definition. The purchaser drafted a new version, which is the subject of dispute under the breach of contract claim, but did not expressly track the seller’s request. The purchaser also circulated a projection sheet showing calculations that are potentially consistent with the purchaser’s definition for the earn-out calculation and potentially contrary to the seller’s claimed understanding of how the parties intended to calculate the earn-out. The seller claimed that during negotiations the purchaser made affirmative representations that the new proposed language was "responsive to" and "reflected" the seller’s views.
The Court found that seller could maintain its action for fraud and fraudulent inducement. Fraud requires a representation of fact that was false and known to be false at the time. In its ruling, the Court found that seller could maintain such a claim on the basis that, as alleged, the purchaser represented a contractual definition that it knew to be different from the definition written into the APA (and reflected in the projections). The Court expressly did not consider the projection sheet at this early pleading stage.
The ruling is significant for anyone negotiating agreements. Alleging fraud, even during negotiations, is certainly not new. But, the ruling in FPP is notable in allowing a fraud claim to proceed based on allegedly false representations concerning a party’s understanding of contractual terms.