In Abry Partners V, L.P., v. F&W Acquisition LLC, 891 A.2d 1032 (Del. Ch. 2006), plaintiffs, a group of Delaware entities affiliated with a private equity firm, ABRY Partners (“ABRY”), sought to rescind a stock purchase agreement (“SPA”) pursuant to which they bought a portfolio company, F&W Publications, Inc. (“F&W”), from an entity owned by another private equity firm, Providence Equity Partners (“Providence”). Prior to the consummation of the SPA, all of the shares of F&W were owned by F&W Acquisition, Inc. (“F&W Acquisition”), which was owned in turn by F&W Acquisition LLC. Because the shares of F&W Acquisition were the key assets being sold, the SPA defined F&W Acquisition as the Company. The owner of the Company, F&W Acquisition LLC, was defined in the SPA as the Selling Stockholder. Providence controlled the Selling Stockholder. For ease of reference, the Providence side of the SPA is sometimes referred to collectively as the Seller. As to the buy-side of the SPA, New Publishing Acquisition, Inc. (“New Publishing”), defined in the SPA as the Acquiror, was the acquisition vehicle through which ABRY purchased the stock of F&W Acquisition in the SPA. The ABRY-controlled Acquiror side of the SPA is sometimes referred to as the Buyer.


As explained more fully below, the SPA stated the Buyer’s promise that it was not relying on any representations and warranties not contained within the SPA and that the Seller made no representations to the Buyer except those delineated in the SPA. The SPA also purported to limit the liability of the Seller for any misrepresentation of fact contained within the SPA to damages not to exceed the amount of a contractually established indemnity fund. The SPA made that indemnity fund the exclusive remedy of the Buyer for misrepresentation, thus, the Seller sought to dismiss the Buyer’s complaint by arguing, among other things, that the SPA barred the rescission remedy sought by the Buyer.

As to the specific factual background of the parties’ dispute, the Buyer alleged that it would be willing to acquire the Company at 10x EBITDA for the period ending June 30, 2005. Ultimately, the parties agreed on a purchase price of $500 million. The SPA was signed June 11, 2005, and the stock sale closed August 5, 2005. According to the Buyer’s complaint, after closing, the Buyer discovered that the Company’s financial statements contained material misrepresentations and did not accurately portray the Company’s financial condition. In general terms, the Buyer claimed that these alleged inaccuracies were the result of (i) financial chicanery and other improprieties that overstated rev- Delaware Court Of Chancery Upholds Freedom Of Contract (With Narrow Exception): Liability Limiting “Non-Reliance” Clause In Stock Purchase Agreement Between Two Private Equity Firms Will Bind Buyer (Mostly) enues, and (ii) the undisclosed failure to implement a product distribution process that allegedly resulted in the loss of important business and constituted a Material Adverse Effect under the SPA. As a result of these alleged unethical business and accounting practices, the Buyer claimed it paid $500 million for a business that was worth approximately $400 million. Three months after closing, the Buyer sued the Seller in the Delaware Court of Chancery claiming that it was fraudulently induced to enter the SPA and demanded for its remedy that the transaction be rescinded.

The Court’s Analysis

Central to the Delaware Court of Chancery’s analysis are certain key provisions of the SPA. The first is the Buyer’s promise that neither the Company nor the Seller made any representation or warranty as to the accuracy of any information about the Company except as set forth in the SPA. Specifically, the SPA provided: Acquiror acknowledges and agrees that neither the Company nor the Selling Stockholder had made any representation or warranty, expressed or implied, as to the Company or any Company Subsidiary or as to the accuracy or completeness of any information regarding the Company or any Company Subsidiary furnished or made available to Acquiror and its representatives, except as expressly set forth in this Agreement.

As is commonplace in the sale of a portfolio company, it is the company that is more intimately aware of its day-to-day affairs and thus makes the fundamental representations and warranties such as those regarding its financial statements. This case was no exception. The Company, not the Seller, represented and warranted that its financial statements fairly presented in all material respects the financial condition of the Company. Indeed, the SPA contained extensive representations from the Company to the Buyer as to the accuracy of the Company’s financial statements and the consistency in the Company’s accounting practices during the pertinent period. Although these were the representations of the Company, the Seller contractually bound itself to stand behind those representations.

Significantly, among the closing conditions was a requirement that the Seller provide an officer’s certificate representing, among other things, that the Company had complied with its covenants in the SPA and that the Company had not suffered events that could reasonably be expected to have a Material Adverse Effect on the Company’s business. The Seller provided the required officer’s certificate, which then formed the basis for the Buyer’s ability to assert claims against the Seller for representations and warranties actually made by the Company. The Seller (or, more particularly, the Selling Stockholder) agreed that after the closing date of the SPA it would indemnify and hold harmless the Buyer from damages that:

… have arisen out of or ... have resulted from, in connection with, or by virtue of the facts or circumstances (i) which constitute any inaccuracy, misrepresentation, breach of, default in, or failure to perform any of the representations, warranties, or covenants given or made by the Company or the Selling Stockholder in [the SPA] The SPA further provided that the only remedy available to the Buyer arising from contractual misrepresentations was an arbitration proceeding for damages as described above. Moreover, the SPA limited the Seller’s liability for damages to an escrowed indemnity fund of $20 million.

After resolving that Delaware law applies to the Buyer’s claims, the Delaware Court of Chancery considered whether Delaware’s public policy permitted the enforcement of those SPA provisions limiting the Buyer’s possible remedy to the $20 million in the indemnity fund established by the SPA. When it comes to commercial parties bargaining at arms-length, the Court held that non-reliance provisions should be enforced in the absence of fraud, which necessarily involves knowing misrepresentations. The Court found support for this rule in the line of Delaware cases holding that clear and express provisions disclaiming reliance on representations outside the four corners of an agreement will preclude a claim based on any such extra-contractual representations. The Court reasoned as follows:

To fail to enforce non-reliance clauses is not to promote a public policy against lying. Rather, it is to excuse a lie made by one contracting party in writing – the lie that it was relying only on contractual representations and that no other representations had been made – to enable it to prove that another party lied orally or in a writing outside the contract’s four corners.

The Court also noted the economic benefits that are thought to result from the enforcement of the terms agreed to by sophisticated parties, such as the avoidance of erroneous litigation outcomes. Of course, the Delaware Court of Chancery had to place its general observations and policy rationales within the context of this particular case, which deals not with claims of extra-contractual misrepresentations, but rather addresses the enforceability of contract terms (here, the exclusive remedy of a claim for damages in arbitration) when the contract itself was allegedly induced by fraudulent statements within that document itself. As stated by the Court:

This case, however, raises a related, but more difficult, question: to what extent may a contract exculpate a contracting party from a recission or damages claim based on a false representation of fact made within the contract itself? Many parties premise a contract on defined representations but promise in advance to accept a less-than-adequate remedy if one of them had been induced by lies about one of those material facts?

To answer this question, the Court had to balance, on the specific facts before it, its respect for freedom of contract against its abhorrence of fraud. While recognizing that Delaware courts are loathe to immunize fraud, the Vice Chancellor also pointed out the commercial reality that sophisticated businesses, such as the Buyer and Seller in this case, are in a better position than the courts to make judgments about their relative risk tolerance and the amount of due diligence they elect to undertake. Relatedly, the Delaware Court of Chancery opined that fraud could be policed by purely economic means. For example, if the Seller attempts to sell portfolio companies based on false representations, it will suffer reputational damage in the private equity sector, thus providing a disincentive to deal dishonestly:

When fashioning common law limits on contractual freedom, we must be mindful of these factors and other commercial realities, lest we inhibit economic activity that might be valuable to the parties and society more generally. In that respect, the common law ought to be especially wary about relieving sophisticated business entities of the burden of freely negotiated contracts. There remains much harshness in the world, and such entities are unlikely candidates to place at the head of the line for judicial protection, especially when the legislature is free to consider providing such relief.


At the same time, a concern for commercial efficiency does not lead ineluctably to the conclusion that there ought to be no public policy limitations on the contractual exculpation of misrepresented facts.... [T]here is little support for the notion that it is efficient to exculpate parties when they lie about the material facts on which a contract is premised.

The Court found a moral difference between such “lies” (i.e., knowing misrepresentations) and other reckless or negligent misrepresentations. The Court also found a practical difference between the two species of misrepresentations, because the level of self-investigation required of a seller making a representation is, according to the Court, a better subject for potential bargaining than whether the seller should be able to insulate itself from liability for lies. Finally, the Delaware Court of Chancery considered the General Assembly’s treatment of exculpatory provisions in particular types of contracts. For example, a corporate charter may exculpate directors from personal liability for acts of gross negligence, but not for acts of disloyalty, bad faith, or intentional misconduct.

In the alternative entity context, the agreements governing limited liability companies and limited partnerships may expand, restrict, or even eliminate duties (including fiduciary duties) of members, managers, and partners. Noting the extent to which the General Assembly is solicitous of freedom of contract, particularly between and among sophisticated parties, the Court concluded its analysis as follows: Given these statements of policy by our General Assembly, it is appropriate for the judiciary in fashioning common law to give as much leeway to sophisticated business parties crafting acquisition agreements as is afforded to those who write the governing instruments of limited partnerships and limited liability companies. We should be reluctant to be more restrictive of freedom of contract than those elected by our citizens to write statutory law.

Accordingly, the Court concluded that the Buyer could avoid the SPA’s contractual limitations on remedies only by showing that the Seller made knowing misrepresentations in the SPA. Thus, Delaware’s public policy will not countenance the Seller’s attempt to insulate itself from the remedy of recission if the Buyer can show at trial that the Seller knew the Company’s representations and warranties were false or that the Seller itself lied to the Buyer about a contractual representation and warranty. The Court noted that to establish such a lie or knowing misrepresentation, the Buyer must show that the Seller “acted with an illicit state of mind” in the sense that it knew the representation or warranty at issue was false. Anything less than a knowing misrepresentation will be insufficient, as the “Buyer knowingly accepted the risk that the Seller would act with inadequate information.”

It is important to note that this decision does no violence to Delaware’s strong tradition of upholding freedom of contract. Indeed, much of the Vice Chancellor’s opinion is an affirmation of that tradition. In that vein, the Delaware Court of Chancery noted in its opinion that the Buyer and Seller could have allocated the risk of intentional lies by the Company’s managers to the Buyer. Such an allocation would have required the Buyer to look to the Company only for recourse. By his decision, the Vice Chancellor has merely identified a limited public policy exception to freedom of contract, an exception based on the specific facts of this case. It is also important to note the procedural posture in which this decision was penned. The Court was considering a motion to dismiss, which required it to accept as true all well-pled allegations in the Buyer’s complaint. We will never know whether the Buyer would have been able to prove at trial that the Seller lied when it made its own representations and warranties in the SPA or when it stood behind the Company’s representations and warranties by signing the officer’s certificate because the case has since settled.