This article is Part I in the Many Splendors of Fraud Claims series by Glenn D. West.
I know that many believe that all that could be written about avoiding fraud claims in private company M&A has been written. However, ABRY Partners V, L.P. v. F & W Acquisition LLC[1] continues to give birth to additional progeny (in the form of new, recent cases) that require attention and possible modification of drafting practices in response. In a series of articles over the next few weeks, I will address some of these recent additions to the ABRY Partners lineage. We will begin with Labyrinth, Inc. v. Urich.[2]
Background of the Labyrinth Case
Labyrinth involved a stock purchase agreement (“SPA”) that contained the following relevant provisions:
SPA Section 9.3:
The agreement of the parties that is comprised of this Agreement sets forth the entire agreement and understanding among the parties with respect to the subject matter hereof and supersedes any and all prior agreements, understandings, negotiations and communications, whether oral or written, relating to the subject matter of this Agreement. In the event of any inconsistency between the statements in the body of this Agreement and those in the Ancillary Documents, any Exhibit and the Disclosure Schedules (other than an exception expressly set forth in the Disclosure Schedules), the statements in the body of this Agreement will control.[3]
SPA Section 4.28:
Except for the representations and warranties contained in Section 3 and this Section 4 (including the related portions of the Disclosure Schedules), none of Seller, the Company or any other Person has made or makes any other express or implied representation or warranty, either written or oral, on behalf of Seller or the Company, including any representation or warranty as to the accuracy or completeness of any information regarding the Company furnished or made available to Buyer and its Representatives[,] or any information, documents or material made available to Buyer in expectation of the transactions contemplated hereby[,] or as to the future revenue, profitability or success of the Company, or any representation or warranty arising from statute or otherwise in law.[4]
SPA Section 5.27:
Buyer has conducted its own independent investigation, review and analysis of the business, results of operations, prospects, condition (financial or otherwise) or assets of the Company, and acknowledges that it has been provided adequate access to the personnel, properties, assets, premises, books and records, and other documents and data of Seller and the Company for such purpose. Buyer acknowledges and agrees that in making its decision to enter into this Agreement and to consummate the transactions contemplated hereby, none of Seller, the Company or any other Person has made any representation or warranty as to Seller, the Company or this Agreement, except as expressly set forth in Sections 3 and 4 of this Agreement (including the related portions of the Disclosure Schedules).[5]
Sections 3 and 4 of the SPA apparently contained the representations of the company and the seller, respectively, and section 5 apparently contained representations of the buyer.
Following the closing of the transaction in Labyrinth, the buyer sued the seller for both intra-contractual fraud (i.e., fraud in the representations and warranties set forth in the SPA) and extra-contractual fraud (i.e., fraud allegedly committed outside the specific representations and warranties made in the SPA). The extra-contractual fraud allegations were largely based upon oral assurances allegedly made by the seller that the “key financial performance metrics—fourth quarter collections, profits, and accounts receivable—were all unaffected by Seller’s collection practice disclosures.”[6]
Understanding the Court’s Ruling: A Multiple-Choice Quiz
Which of the following statements are likely true about the action of the Delaware Court of Chancery in ruling on the seller’s motion to dismiss the extra-contractual fraud counts?
- The court was unpersuaded that section 9.3 was relevant to the motion to dismiss the extra-contractual fraud claims because it was a mere “integration clause” that “does not operate as a bar to fraud claims, but rather simply . . . limit[s] the scope of the parties’ contractual obligations to those set forth in the written agreement.”[7]
- The court was unpersuaded that section 4.28 had any effect to disclaim the buyer’s reliance on extra-contractual statements of the seller because section 4.28 was a statement by the seller “of what [the seller] was and was not representing and warranting”; it was not a statement by the buyer of what the buyer was relying upon.[8]
- The court was unpersuaded that section 5.27 was effective as a no-reliance clause because the first sentence of section 5.27 “details all the information that formed Buyer’s own independent analysis of the company, including the extracontractual information Seller provided,”[9] and the second sentence “does not disclaim reliance on any extracontractual information.”[10]
- The court dismissed the extra-contractual fraud claims because no “magic words” are required in Delaware to disclaim reliance upon extra-contractual representations,[11] and sections 4.28 and 5.27 taken together demonstrate “‘that the Buyer only relied on the representations and warranties in the SPA,’ thereby ‘establish[ing] the universe of information on which that party relied,’ and, together with an integration clause [SPA section 9.3], ‘add[ed] up to a clear anti-reliance clause.’”[12]
Take a moment to test yourself before reading further.
* * *
“A” is clearly correct. Courts across the country say this all the time. Section 9.3 did not even have any anti-reliance language respecting purported extra-contractual representations; it simply excluded oral agreements from constituting part of the parties’ contract.
“B” is also correct. The old practice (which is still followed by some) of having the seller’s representations include a concluding representation (by the seller) that the seller has not made any representations other than those set forth in the agreement simply does not work. It is technically not a statement of no reliance but instead a statement that no extra-contractual representations were made (i.e., it is a “no-representations” clause rather than a “no-reliance” clause). And even if a statement that “no representations” outside the agreement were made by the seller is deemed sufficient as an effective disclaimer of reliance in Delaware, Delaware has long been insistent that the buyer must make that statement. Here, the seller (section 4), not the buyer, made the statement.[13]
The better practice, of course, is to make sure that the statement both is a statement of no reliance and is made by the buyer. Indeed, an effective anti-reliance clause requires not only correct language but also correct placement in the agreement. I have even likened the creation of an effective disclaimer of extra-contractual representations to the effective means of “neutralizing” a flesh-eating zombie—it requires a specialized weapon to administer a blow to a precise spot.[14]
“C” is a little tougher. In Texas (and perhaps other states), section 5.27 would clearly not work because there is no express use of the word rely or reliance. Moreover, simply stating (even from the buyer’s perspective) that no representations have been made is ineffective to defeat extra-contractual fraud in Texas.[15] Instead, what is required in Texas is a clear statement that the buyer did not rely upon any statements that may have been made (even though the parties agreed that no statements were made). According to the Texas Supreme Court, “[t]here is a significant difference between a party disclaiming its reliance on certain representations, and therefore potentially relinquishing the right to pursue any claim for which reliance is an element, and disclaiming the fact that no other representations were made.”[16] The former (disclaiming reliance) works, but the latter (disclaiming a fact) does not.
However, in Prairie Capital III, L.P. v. Double E Holding Corp.,[17] the Delaware Court of Chancery rejected this strict approach requiring specific language disclaiming “reliance.” Instead, the Delaware Court of Chancery declared that “Delaware law does not require magic words.”[18] Rather, “[l]anguage is sufficiently powerful to reach the same end by multiple means, and drafters can use any of them to identify with sufficient clarity the universe of information on which the contracting parties relied.”[19] While I never was completely sure of what constituted that other “sufficiently powerful” language,[20] one might be tempted to view the second sentence of section 5.27 (which is a statement coming from the buyer proclaiming that there are no other representations other than those made by the seller and the company in the agreement) as sufficient, under Delaware law, to define the universe of information upon which the buyer was relying despite the failure to use the words disclaim reliance or did not rely.
But in Labyrinth, Vice Chancellor Zurn stated that the first sentence of section 5.27 “can be read to reflect that Buyer was expressly representing it did rely on extra-contractual information” by stating that the buyer “conducted its own independent investigation” from information that was provided by the seller.[21] In other words, the first sentence suggests that “Buyer formed a judgment or opinion of ‘the business, results of operations, prospects, condition (financial or otherwise), or assets of the Company’ from what Seller provided, namely ‘the personnel, properties, assets, premises, books and records, and other documents and data of Seller and the Company for such purpose.’”[22] But then, according to Vice Chancellor Zurn, the second sentence merely “identifies Seller’s representations[;] . . . it [does not] preclude[] Buyer’s reasonable reliance on representations that are not identified.”[23] Stated differently, in the second sentence, “Buyer did not affirmatively acknowledge any disclaimer by Seller, or otherwise specifically establish the universe of information on which Buyer did or did not rely.”[24]
The safer course is always to think of Delaware as effectively Texas, and to have the Buyer always expressly disclaim reliance on any extra-contractual statements.[25]
Now, as to “D.” Vice Chancellor Zurn refused to find that the combination of three ineffective clauses (what Vice Chancellor Zurn called “a standard integration clause [9.3], an independent investigation clause [5.27], and a representation and warranty clause [4.28]”)[26] somehow collectively constituted an effective disclaimer of reliance. As I long ago warned, while Delaware may claim that there no “magic words” required to effectively create an exclusive universe of contract-based representations and warranties upon which any fraud claim must be premised and thereby eliminate the “dog’s breakfast”[27] of extra-contractual claims, you should assume there actually are required magic words—and use them.
So, the correct answers are A, B, and C.
The Playbook for Disclaiming Extra-Contractual Fraud Claims
To defeat extra-contractual fraud claims, (a) actual disclaimers of reliance should be used, not simple “no representations” statements; (b) disclaimers of reliance should be properly placed in the acquisition agreement so that they are coming from the point of view of the buyer;[28] and (c) the disclaimer of reliance should be “robust” (i.e., disclaim reliance on an exhaustive list of things that might be provided or discussed in the lead-up to the execution of the agreement).[29] And, based on Labyrinth, including an independent investigation provision does not necessarily add anything and may in fact do more harm than good, particularly when it suggests that there was a lot of information provided by the seller upon which the buyer relied.
ABRY Partners and its extensive progeny have provided a “playbook” for effectively disclaiming extra-contractual fraud claims in Delaware. While Prairie Capital may have suggested there were some easy outs from actually reading and applying that playbook strictly, do not fall into that trap. You are expected to have fully read the playbook and found the $100 taped to the last page.[30]
891 A.2d 1032 (Del. Ch. 2006). ↑
2024 WL 295996 (Del. Ch. 2024). ↑
Id. at n.188. ↑
Id. at n.190. ↑
Id. at *16. ↑
Id. at *12 (quoting Complaint at ¶ 80, Metro Commc’n Corp. BVI v. Advanced Mobilecomm Techs. Inc., 854 A.2d 121 (Del Ch. 2024)). ↑
Id. (quoting Kronenberg v. Katz, 872 A.2d 586, 592 (Del. Ch. 2004)). ↑
Id. (quoting FdG Logistics LLC v. A&R Logistics Holdings, 131 A.3d 842, 860 (Del. Ch. 2016)). ↑
Id. at *17. ↑
Id. at *18. ↑
Prairie Cap. III, L.P. v. Double E Holding Corp., 132 A.3d 35, 51 (Del. Ch. 2015) (see infra note 18 and accompanying text). ↑
Labyrinth, 2024 WL 295996, at *18 (quoting Prairie Cap., 132 A.3d at 51). ↑
See FdG Logistics, 131 A.3d at 860. ↑
Glenn D. West, The Surprising Connection Between an Extra-Contractual Fraud Claim and a Flesh-Eating Zombie, Weil’s Glob. Priv. Equity Watch (Mar. 3, 2016). ↑
Italian Cowboy Partners, Ltd. v. Prudential Ins. Co. of Am., 341 S.W.3d 323 (Tex. 2011). ↑
Id. at 335 (emphasis in original). ↑
132 A.3d 35. ↑
Id. at 51. ↑
Id. ↑
In Prairie Capital, while not expressly disclaiming reliance on extra-contractual representations, the buyer did state that the buyer “agrees that all [extra-contractual representations] are specifically disclaimed by the [seller].” Id. at 50. This language was obviously not present in section 5.27. In addition, Prairie Capital did not contain the unfortunate first sentence of section 5.27; instead, it simply said that “[t]he Buyer acknowledges that it has conducted to its satisfaction an independent investigation of the financial condition, operations, assets, liabilities and properties of the [seller].” Id. ↑
Labyrinth, Inc. v. Urich, 2024 WL 295996, at *17 (Del. Ch. 2024) (quoting Anschutz Corp. v. Brown Robin Cap., 2020 WL 3096744, at *14 (Del. Ch. 2020)) (emphasis in original). ↑
Id. (quoting SPA section 5.27). ↑
Id. at *18. ↑
Id. ↑
See Glenn D. West, Avoiding the Other F-Word: An Anti-Reliance Clause Should Actually Disclaim Reliance on Extra-Contractual Representations Even When the Parties Agree that None Were Made, Weil’s Glob. Priv. Equity Watch (Mar. 25, 2019). An example of an “anti-reliance” provision is available in Glenn D. West, Reps and Warranties Redux—A New English Case, An Old Debate Regarding a Distinction with or Without a Difference, Weil’s Glob. Priv. Equity Watch (Aug. 2, 2016). ↑
Labyrinth, 2024 WL 295996, at *18. ↑
See Glenn D. West, Avoiding a Dog’s Breakfast—Some Timely Reminders of How to Effectively Limit the Universe of Purported Representations upon Which Fraud Claims Can Be Made, Weil’s Glob. Priv. Equity Watch (Aug. 13, 2018). ↑
Of course, sellers should insist that the anti-reliance clauses be reciprocal (i.e., sellers should also disclaim reliance upon any extra-contractual representations purportedly made by the buyer), particularly in cases involving earnouts. ↑
See West, supra note 27. ↑
See Draft Day (Summit Entertainment & Oddlot Entertainment 2014) (Ralph Mowry speaking to Sonny Weaver about Bo Callahan and how Washington checks if their potential players have read the entire playbook). ↑
