In a recent opinion, Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, the Delaware Court of Chancery declined to dismiss claims of fraud and aiding and abetting against four directors related to alleged misrepresentations made by target company officers in connection with a merger.1 The court’s opinion provided guidance as to factual allegations sufficient to plead claims that directors and shareholders may have had knowledge of and/or aided an alleged fraud.


The buyer acquired a privately held company, Plimus, Inc. (Plimus), which was in the business of facilitating online payments. The target’s business was dependent on its relationship with payment processors, such as PayPal and Paymentech, who were two of Plimus’ largest service providers. Paymentech terminated its contractual relationship with Plimus before the merger, and PayPal terminated its relationship eight days after the closing of the merger. Following the closing, the buyer discovered pre-merger communications indicating Plimus executives made fraudulent misrepresentations to, and withheld material information about the terminations from, the buyer in connection with the merger.2

In addition to claims against Plimus’ former CEO and Vice President of Financial Strategy and Payment Solutions based on fraud, the buyer also sought to recover against four former directors and SIG Growth Equity Fund I LLLP, Plimus’ largest shareholder (SIG Fund), and its agent for fraudulent inducement, fraud and/or conspiracy, and aiding and abetting the executives to commit fraud, and against a group of shareholders for indemnification and/or unjust enrichment. Two of the defendant directors were appointed by the SIG Fund, and the other two defendant directors were founders owning collectively 44 percent of Plimus’ outstanding voting stock.

Fraud Claims Against Directors and Stockholders

The buyer alleged three distinct sets of circumstances that involved fraudulent actions. First, the buyer alleged that both the defendant executive officers and the two SIG Fund directors concealed the real reason for the termination of Plimus’ relationship with Paymentech. The buyer alleged that the directors, who were informed of the situation with Paymentech, allowed the CEO to rewrite the disclosure regarding the termination to mislead the buyer into thinking that Plimus had instigated the termination of the relationship; this disclosure replaced an earlier, accurate draft. Second, buyer alleged that the two SIG Fund directors, as well as the two executive officers, concealed the extent of the company’s violations of various PayPal procedures and requirements and PayPal’s threat to terminate its contract due to such violations. The buyer claimed that the two SIG Fund directors supported the CEO’s fraudulent strategy to maintain an appearance of Plimus’ revenue and profits, such as by shifting accounts between PayPal and another payment processor. Third, buyer alleged that the SIG Fund directors, the SIG Fund and the founder directors made extra-contractual “black-mail” payments to the CEO to encourage him to roll over his equity into the new company, so as to avoid raising any red flags as to his confidence in the target company. Further, the directors and executives allegedly  misrepresented the circumstances surrounding the additional compensation and led the buyer to believe that it was a part of a pre-existing arrangement with the CEO, rather than additional compensation.

The plaintiffs alleged that the defendant directors and the SIG Fund, along with the two executive officers, “knowingly entered into a confederation or combination to fraudulently induce Great Hill” to enter into the merger agreement. The Chancery Court held that to meet the pleading standard for a conspiracy to commit fraud, the plaintiffs only had to plead facts permitting an inference that the alleged fraud “was knowable” and that the directors and the SIG Fund were “in a position to know it.” The purpose of the pleading requirement was to give the defendants “adequate notice of the basis of their alleged wrongdoing.” The Chancery Court assessed the allegations and concluded that this standard was met here with respect to the misleading of Great Hill concerning the true nature of the Paymentech termination and the impending PayPal termination, as well as the reasons for the additional compensation to the CEO.

In reviewing the allegations in the complaint, the Chancery Court provided guidance as to the ways in which directors and shareholders allegedly became part of the confederation to commit fraud. The complaint alleged that the SIG Fund directors reviewed the proposed, accurate disclosure about the Paymentech issues, as well as the revised, allegedly fraudulent disclosure prepared by the CEO. The founder directors had sought access to the data room where the disclosure was displayed for the buyer, and participated directly in the sales process. The founder directors were told by the CEO that Paymentech was closing the company’s account, which would have allowed those directors to know that the mutual termination of the relationship disclosed to the buyer was false. They were copied on an email to Paymentech from company counsel describing the termination as “unilateral.”

The plaintiffs noted that the four directors’ involvement in the sales process itself supported an inference that they “were aware of the catastrophic problems with PayPal and of [the company’s] deeply misleading disclosures.” The Chancery Court itself observed that “it strikes me as unlikely that [the directors] were unaware of the impending and allegedly catastrophic loss of the relationship with PayPal.” Accordingly, the Chancery Court found that there was adequate pleading for an alleged “confederation” to further the fraud by the directors and the officers, and that the four directors had control over the CEO, the apparent ringleader of the alleged fraud. The Chancery Court also noted their financial motive as large blockholders (the founder directors owned 44 percent of Plimus, and the SIG Fund was the largest shareholder), not to exercise control to stop the CEO from continuing the fraud. The Chancery Court observed that it was also reasonable to infer at least a tacit agreement among the defendant directors and shareholders to perpetrate the fraud.

Applicability of Indemnification Limitations In Case of Fraud

Another contested issue in Great Hill was whether the contractual indemnification limitations and cap were applicable to claims of breach based on fraud. Under the merger agreement, indemnification for breach of representations and warranties was several, and not joint, and subject to a $500,000 deductible and capped at $9.2 million escrow. While the remedy for fraud was not specifically addressed, there was an “Exclusive Remedy” subsection, which provided  that “. . . except. . . in the case of fraud or intentional misrepresentation (for which no limitations set forth herein shall be applicable). . . the sole and exclusive remedies of the parties for any claim for breach of any covenant, agreement, representation or warranty. . . will be limited to those contained in this [Indemnification Section].” The buyer contended that unlimited indemnification was available for fraud, and that holders were jointly and severally liable and must indemnify the buyer for the full amount of its losses. The defendants argued that the buyer must seek tort damages for fraud outside the limits of the indemnification against the perpetrators of fraud, and that the language in the merger agreement only exempted recoveries against fraudsters from the indemnification limitations.

On the question of whether contractual limitations on indemnification were applicable to breach of representations and warranties claims based on fraud, the court did not rule on the interpretation of the language in the Great Hill merger agreement. The court suggested, however, that it believed the defendants’ view—that the language only exempted recoveries against fraudsters from the indemnification limitations and did not intend to result in unlimited indemnification for any claims based on fraud—was more commercially reasonable. Where  there was ambiguity in the merger agreement, the court would look for evidence of the parties’ intent and might favor an approach that more closely followed the contractual remedy agreed to by the parties.