This article is Part III in the Many Splendors of Fraud Claims series by Glenn D. West, which explores recent cases that affect drafting practices for avoiding fraud claims in private company M&A.
In a recent order denying a motion for reargument in Surf’s Up Legacy Partners, LLC v. Virgin Fest LLC, the Delaware Superior Court was faced with a claim that the “Fraud” carved out from an Asset Purchase Agreement’s (“APA”) indemnification caps did not require proof of reliance.[1]
A Fraud Definition without a Mention of Reliance
Fraud was defined in the APA as “any false representation, misrepresentation, deceit, or concealment of a fact with the intention to deceive, conceal or otherwise cause injury.”[2] The definition then went further to state that “‘Fraud’ shall not include constructive fraud or other claims based on constructive knowledge or merely negligent misrepresentation or similar theories.”[3] The defined term Fraud was then used in the indemnification provision to eliminate all of the contractual limitations and caps on losses “in the event of any breach of a representation or warranty by any Party hereto that results from or constitutes Fraud.”[4]
The buyer argued that this definition of Fraud “clearly obviates the normal (or common law) requirement of reliance, because reliance is not mentioned in the provision.”[5] While the court noted that the parties could have eliminated reliance as an element of the fraud claim, the court refused to find that this particular definition did so. It helped that the definition stated that a “false representation [or] misrepresentation” had to be “with the intention to deceive, conceal or otherwise cause injury.”[6] Moreover, the disclaimers all related to lesser states of mind applicable to fraud. Therefore, the court concluded that all this definition did was incorporate the common-law concept of fraud while eliminating “fraud claims with a state of mind less than intentional knowledge.”[7] What the definition did not do, according to the court, was constitute “a waiver of reliance.”[8]
Less Versus More
That is great, but this case did make me pause and consider that we sometimes say both less and more than we need to—and we leave things out in the process.
It is not uncommon to see definitions of Fraud that do not actually use the word fraud in them; instead, they simply refer to intentional or deliberate misrepresentations or breaches of the express representations and warranties. In that context, would the buyer have to prove reliance?
And there are those definitions of Fraud that, while not using the term fraud in the definition, nevertheless include all of the elements of common-law fraud, including reliance. A good example can be found in the August 13, 2024, Stock Purchase Agreement governing the $2.095 billion Performance Food Group Company’s acquisition of the stock of Cheney Bros., Inc.:
“Actual Fraud” means the making by a Party,[9] to another Party, of a representation or warranty contained in Article 3, Article 4 or Article 5; provided that at the time such representation or warranty was made by such Party (a) such representation or warranty was inaccurate, (b) such Party had actual knowledge (and not imputed or constructive knowledge), without any duty of inquiry or investigation, of the inaccuracy of such representation or warranty, (c) in making such representation or warranty such Party had the intent to deceive such other Party and to induce such other Party to enter into this Agreement or consummate any transaction contemplated hereby and (d) such other Party acted in reasonable reliance on such representation or warranty; provided that for the purposes of this definition, the Party making the representations and warranties of the Company in Article 3 shall be limited to the Persons listed in the definition of Knowledge. For the avoidance of doubt, “Actual Fraud” does not include equitable fraud, promissory fraud, unfair dealings fraud, or any torts (including fraud) based on negligence or recklessness.
Note that the term fraud is not used in the above definition, except in the “avoidance of doubt” clause at the end. If clause (d) had been left out of this definition, could an argument be made that reliance is not required to prove “Actual Fraud” for the purposes of this agreement? Would your answer change if the “avoidance of doubt” clause had been left out too? Not sure? Why take the chance?
All we are trying to do from the sell side, and sometimes from the buy side (particularly if there is an earnout), is to limit fraud claims to those that cannot be eliminated in any event in Delaware—i.e., “intentional and knowing common law fraud claims respecting the express representations and warranties in the agreement.” Using the term intentional and knowing common law fraud should mean that the elements of common-law fraud (including reliance) have to be satisfied but that the scienter requirement excludes recklessness. In addition, equitable fraud is off the table, too, because it is not common-law fraud.
Accordingly, the following definition from the July 18, 2024, Purchase Agreement governing Amphenol Corporation’s $2.1 billion acquisition of certain assets of CommScope Holding Company, Inc., might provide less risk of getting it wrong:
“Fraud” means actual,[10] intentional and knowing common law fraud under Delaware law in the making of the representations and warranties set forth in Article 4 or Article 5 (each as qualified by the Schedules to the Disclosure Letter), or in any certificate delivered pursuant to Section 7.2(d) or Section 7.3(g), and specifically excluding equitable fraud or constructive fraud of any kind (including based on constructive knowledge or negligent misrepresentation).
I certainly do not have a problem with the more elaborate definitions, particularly those that disclaim lesser scienter requirements specifically, as well as all the other types of fraud. However, try not to open the door to arguments that you were defining Fraud in a manner that did not include all of its common-law elements.
No. N19C-11-092 PRW CCLD, 2024 WL 3273427 (Del. Super. Ct. July 2, 2024) (order denying motion for reargument). ↑
Id. at 4 (quoting APA, annex II at 3). ↑
Id. (quoting APA, annex II at 3). ↑
Id. at 4 n.11 (quoting APA § 6.04). ↑
Id. at 4. ↑
Id. ↑
Id. at 5. ↑
Id. ↑
In the next article in this series, we will discuss the fact that the common practice of limiting fraud to the party making the representations does not work the way that many deal lawyers apparently think it does. So, stayed tuned on that one. ↑
I actually prefer leaving the term actual out. It seems like all common-law fraud types are actual (or “real”) fraud—we just like to think that anything other than the intentional variety is not “actual,” but constructive, fraud. Probably not fatal, but I certainly do not think the term actual adds anything to intentional and knowing. In addition, please do not use just the term actual alone, assuming that it means an intentional or knowing misrepresentation. There is case law defining actual fraud as not necessarily involving a representation at all—just some kind of deceitful activity that has been given the moniker unfair dealings fraud; and there is certainly case law that would implicitly include recklessness (not just intentionality) in the concept of “actual fraud,” even if it was confined to a misrepresentation. See Glenn D. West, That Pesky Little Thing Called Fraud: An Examination of Buyers’ Insistence upon (and Sellers’ Too Ready Acceptance of) Undefined “Fraud Carve-Outs” in Acquisition Agreements, 69 Bus. Law. 1049, 1063–64 (2014); see also Husky Int’l Elecs., Inc. v. Ritz, 578 U.S. 355, 362 (2016) (noting that “a false representation has never been a required element of ‘actual fraud’”). ↑