The Court of Chancery, in Cobalt Operating LLC v. James Crystal Enterprises, LLC, 2007 WL 2142926 (Del. Ch. July 20, 2007), found that defendants committed fraud in the course of selling a radio station to plaintiff and, as a result, the Court awarded over $11 million in monetary damages to plaintiff (including the cancellation of a $5 million promissory note and the cancellation of defendants’ $2 million equity interest in plaintiff). The damage figure represented the difference between the actual value of the radio station at the time of the sale and the $70 million purchase price. The Court also awarded pre-judgment interest on the monetary portion of the award, as well as awarded plaintiff’s attorneys’ fees and costs pursuant to the Asset Purchase Agreement.

In March 2002, plaintiff purchased a West Palm Beach, Florida, radio station – WRMF – from defendants for $70 million. Plaintiff’s willingness to pay the $70 million purchase price was based on defendants’ representation that WRMF’s annual broadcast cash flow was $5 million (plaintiff was willing to pay 14 times cash flow). Plaintiff confirmed the accuracy of the $5 million figure through due diligence conducted in June 2002, and based on that confirmation the transaction closed. Approximately three months later, after WRMF’s traffic manager had resigned, plaintiff noticed that it could not fit all of the commercials that it had sold into WRMF’s daily on-air schedules, which struck plaintiff as odd because WRMF was not selling any more commercials than it had sold when defendants owned the station. When the problem persisted and plaintiff could not figure out what was causing the problem, it attributed the problem to defendants’ fraud.

Plaintiff filed a lawsuit asserting claims for fraud and breach of contract. Plaintiff asserted that in the period leading up to the sale, defendants sold more pre-recorded commercial advertising to WRMF’s customers than WRMF was able to air and then billed the advertisers (and collected) for ads that WRMF did not run. As a result, WRMF’s cash flow was artificially inflated by approximately $1 million a year, which caused plaintiff to overpay for the station by $12 million. Defendants listed many reasons for the discrepancy and argued that because plaintiff did not come forward with any admission by one of defendants’ former employees confessing that the fraud actually occurred, plaintiff did not sustain its burden of proof.

Based on one week’s worth of trial testimony and thousands of pages of briefs and exhibits, the Court concluded that the ads in question did not run and that defendants offered no reasonable explanation for the bad billings to advertisers. The Court also concluded that defendants and several of their employees were motivated to defraud plaintiff so that they could obtain a higher price for WRMF. The Court held that plaintiff “clearly satisfied the elements of its common law fraud claim, as it proved that [defendants] intentionally provided it with false financial information on which it reasonably relied in entering into the transaction and which cause it to overpay for WRMF.” The Court noted that plaintiff also established the elements of equitable fraud, which requires similar proof except that scienter is not required. The Court held that plaintiff also proved its breach of contract claim because defendants represented in the Asset Purchase Agreement that the financial statements (showing an annual cash flow of $5 million) provided to plaintiff were not materially misleading. Instead, “nearly 20% of that cash flow was attributable to the fraud perpetrated by [defendants] on its customers.” Thus, the financial statements were materially misleading, and defendants breached their representation to the contrary.

The Court awarded plaintiff its expectation damages and, in rejecting defendants’ contention that the Court must only rescind the Asset Purchase Agreement, stated, “when a contract or agreement is silent as to the remedy for a breach, the Court of Chancery has the discretion to award any form of legal or equitable relief and is not limited to awarding contract damages for breach of the agreement.” The Court awarded the following relief for defendants’ fraud and breach of contract: (i) $4 million in monetary damages, (ii) the cancellation of a $5 million promissory note, (iii) the cancellation of defendants’ $2 million equity interest in plaintiff, (iv) indemnification in the amount of $180,745 in advertiser credits plaintiff provided to the defrauded advertisers of WRMF, (v) pre-judgment interest on the $4 million award, and (vi) attorneys’ fees and costs. While the fee award was based on an indemnification provision contained in the Asset Purchase Agreement, the Court noted that it would have awarded substantial fees under the bad faith exception to the American rule, as a result of defendant’s many baseless arguments.