Not that long ago, the overwhelming majority of private company acquisition agreements contained broad, undefined fraud carve-outs to the otherwise exclusive remedies provided for in the indemnification provisions. Indeed, in a 2014 article published in The Business Lawyer, the practice of clearly defining and limiting the broad term “fraud” was identified as a then “minority trend” that the “author hope[d] … w[ould] become a dominant market practice for negotiated fraud carve-outs.”[1] Well, guess what? It now appears clear that the practice of defining fraud for the purpose of a fraud carve-out to the exclusive remedy provision is, in fact, a dominant market practice. The question today is seldom whether the term “fraud” is to be defined, but instead is how it is defined and from what provisions the defined Fraud carve-out is carved out. Fraud carve-outs have come of age.

The prior market practice of including broad, undefined fraud carve-outs in private company acquisitions agreements derived from a fairly common view that their inclusion was sleeves off one’s vest because there was actually nothing one could do contractual to address extra-contractual tort claims, particularly those premised on some form of the evil sounding term “fraud.” That common view was debunked in 2006, at least in Delaware, by then Vice-Chancellor Strine’s landmark decision in ABRY Partners V, L.P. v. F & W Acquisition LLC, 891 A.2d 1032 (Del. Ch. 2006). But negotiating an actual definition of “fraud” appears to have still been a minority practice as late as 2014. That has now clearly changed.

A review of just the last few months of publicly filed private company acquisition agreements reveals that the overwhelming majority of those agreements contain a specific definition of the term “Fraud.” But just because parties are negotiating those definitions does not mean that all such definitions are equal when it comes to protecting selling stockholders and their representatives from the many varieties of fraud claims, or the potential sources of statements that can form the basis for those claims. And where these defined Fraud carve-outs appear in various provisions can have potential consequences too.

For example, in one recent private company acquisition agreement, the term “Fraud” was defined as follows:

“Fraud” means common law fraud and equitable fraud, under Delaware Law.

When that term is then used as a carve-out to the exclusive remedy or survival provision, or worse yet, to the no reliance clause, one can well wonder what the point of defining the term was in the first instance. Common law fraud includes fraud premised not only upon knowing misstatements of fact, but also upon statements made recklessly (not knowingly false, but with insufficient information to know whether the statement was true);[2] and equitable fraud can be based on negligent or even innocent misstatements of fact (meaning an unintentional failure to include a disclosure in the disclosure schedules could potentially constitute equitable fraud and thereby undo the limited or no indemnity deal).[3] Moreover, in both cases the source of these statements can be either extra-contractual or intra-contractual. Thus, a no reliance clause that disclaims reliance on extra-contractual statements, “except in the case of Fraud” (defined as above), may well be worthless—i.e., Buyer has not relied upon any extra-contractual misstatements, except in the case of any such misstatements that the buyer has relied upon.[4] Huh?

Another definition from a recent private company acquisition agreement is equally deficient in protecting the sell-side from a broad array of potential fraud claims. While limiting Fraud to the common law variety, the following definition still leaves open the possibility of claims being premised on recklessness. Moreover, both intra-contractual and extra-contractual misstatements are included (which can be particularly problematic when, as was the case in this particular agreement, this defined Fraud is carved out from the no reliance clause in addition to the exclusive remedy provision:

“Fraud” means Delaware common law fraud; provided that “Fraud” shall not include constructive fraud, equitable fraud or fraud inferred or presumed by conduct rather than a false representation.[5]

If the parties intended these potential outcomes, and specifically negotiated this definition of Fraud with those outcomes in mind when placing the Fraud carve-out in each of the various affected clauses, great. But did they?

Despite these troubling examples, the vast majority of the recently filed purchase agreements, define Fraud so that it is limited to the representations and warranties set forth in the purchase agreement and leaves intact the no reliance clause that disclaims any reliance by the buyer upon any purported statements made outside of the written agreement. But even here there can be some anomalies. For example, one recent agreement defined fraud as follows:

“Fraud” means, with respect to any Person, fraud of such Person in respect of any of the express representations and warranties of such Person set forth in this Agreement or in any other Transaction Document.

It is certainly good from the sell-side to limit the universe of purported statements upon which a fraud claim can be premised to just those expressly contained within the four corners of the agreement, but defining uppercase Fraud as lower case fraud respecting those express representations and warranties does little to eliminate the potential for claims based upon equitable fraud or the reckless common law variety of fraud, even though premised solely upon the express representations and warranties.[6]

But the vast majority of the recently filed purchase agreements contain some variation of the following definitions of Fraud, which limit Fraud to just the morally egregious variety respecting the bargained for representations and warranties expressly negotiated as the actual factual predicates for the deal:

“Fraud” with respect to any Party[/Person], means an intentional and willful misrepresentation by such Party[/Person] with respect to the making of the representations and warranties by such Party[/Person] set forth in Article III or Article IV, as applicable, or any certificate delivered pursuant to Section 2.6 hereunder, that constitutes common law fraud under the laws of the State of Delaware. For the avoidance of doubt, “Fraud” does not include any claim for equitable fraud, promissory fraud, unfair dealings fraud, constructive fraud, or any torts based on negligence or recklessness.

“Fraud” means actual and intentional fraud under Delaware common law with respect to the making of any representation or warranty in Article 4, Article 5 or Article 6 of this Agreement, as applicable, [committed by and asserted only against the Party/Person committing such actual and intentional fraud].

Some of the agreements go on to specifically identify the persons whose knowledge of the false intra-contractual representation matters for the purpose of establishing intentional fraud, but most do not. Most of the agreements using some variation of these definitions only carved out Fraud in the exclusive remedy and/or survival clause, not in the no reliance clause. But a few agreements using some variation of these definitions did carve out Fraud from the no reliance clause. However, unlike other defined terms for Fraud (which include both intra-contractual and extra-contractual fraud), a Fraud definition that is limited to intra-contractual fraud can hardly be said to have done damage to the basic premise of the no-reliance clause—i.e., a no reliance clause only disclaims reliance on extra-contractual statements and representations to begin with, so carving out from that disclaimer of reliance any intentional fraud respecting only the written representations and warranties seems to be a non-event.[7]

And lest we forget, contractual fraud carve-outs can sometimes create potential liability for innocent sellers in multi-seller transactions too. This can occur because the fraud carve-out is not simply a carve-out to the exclusive remedy provision for a tort-based fraud claim of the specified type, but is also a carve-out to the indemnification claims against all sellers, with the cap removed as a result of the alleged occurrence of the specified fraud by just one of the sellers, or the carve-out broadly removes all limitations of remedies or survival “in the event of Fraud, without being clear that the carve-out only removes those limitations with respect to the Persons actual engaged in the Fraud.[8] Many of the recent agreements appeared to have addressed this issue by clarifying that carved out claims of Fraud may only be pursued against the Persons committing, participating in, or having actual knowledge of such Fraud, but many did not. It is always a good idea to specify that the carved out Fraud claims can only be brought against the Persons who actually committed the defined Fraud (which as a matter of Delaware law includes not only the entity party who may have made those misstatements, but also those human agents who caused the entity party to make those misstatements, and any seller who knew that the misstatements were false when made).[9]

Remember, when representing private equity sellers, who have a particular interest in ensuring that there are no post-closing claims beyond those specifically bargained for, always ask and answer the following questions when crafting your definition of Fraud and the language of the actual Fraud carve-out:

  • What type of fraud claim is intended to be covered by the exclusion? Just common law fraud, or is equitable fraud or promissory fraud intended to be covered?
  • If limited to common law fraud, is it limited to deliberate, knowing misrepresentations, or does recklessness count?
  • Whose fraud counts for purposes of a claim? Is it just the named knowledge parties or any representatives of the sellers or target who may be deemed the sellers’ agents?
  • Against whom can fraud claims be asserted? Any seller, or just the sellers who actually participated in the knowing conveyance of falsehoods?
  • What is the source of the potential statements that can serve as basis for fraud claims? Any statements, or only those specifically bargained for and made part of the written representations and warranties set forth in the agreement?
  • Can fraud claims only be asserted as tort-based claims or can they be asserted as an uncapped indemnification claims?[10]

The answers to these questions for a private equity seller should result in a Fraud carve-out that is limited to the judicially created fraud carve-out mandated by Abry Partners and its progeny: the right to bring a tort-based fraud claim only against a party/person engaging in intentional common law fraud respecting the express representations and warranties set forth in the agreement.

Endnotes    (↵ returns to text)
  1. 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 (2014).
  2. See Glenn West, Delaware Declares That Deliberate Fraud Is Indeed Something Completely Different Than Reckless Fraud, Weil’s Global Private Equity Watch, March 16, 2021, available here.
  3. See West, supra note 1, at 1059-61; see also, Glenn 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 Insights, Weil’s Global Private Equity Watch, August 13, 2018, available here.
  4. See Glenn West, Your Mother Was Right: Following Your Friends (or Market Studies) Off a Bridge is a Bad Idea, Weil Insights, Weil’s Global Private Equity Watch, January 28, 2020, available here.
  5. This recent example limits fraud claims to the intentional variety, but when the defined term is then used as a carve out to the no reliance clause, in addition to the exclusive remedy provision, it opens up extra-contractual statements as sources for this type of fraud, which should have otherwise been eliminated by the no reliance clause: “‘Fraud’ means actual fraud under Delaware law with the intent to deceive, specifically excluding constructive fraud, recklessness or negligence.” Technically, if you leave your no reliance clause pristine (and do not include a fraud carve-out), even an undefined fraud carve-out should be limited to just the representations and warranties in the agreement, because the no reliance clause excludes any extra-contractual representations completely and thereby defines the universe of statements upon which a fraud claim can be premised. However, you would still have the various types of fraud to deal with respecting those representations and warranties. See Glenn West, Exclusive Remedy Provisions, Fraud Carve-outs, and Personal Liability for Sell-Side Private Equity Professionals, Weil Insights, Weil’s Global Private Equity Watch, December 1, 2015, available here.
  6. And this example isn’t much better: “‘Fraud’ means, with respect to any Person, actual fraud of such Person under Delaware common law in connection with the representations and warranties set forth in this Agreement.” (it would appear that “actual fraud … under Delaware common law” would still include “reckless common law fraud” respecting the representations and warranties). Same with this one: “‘Fraud’ or ‘fraud’ means, with respect to a party, common law fraud under the laws of the State of Delaware with respect to the making of the representations and warranties pursuant to Article IV or Article V, any Transaction Documents, or any of the certificates delivered pursuant hereto or thereto, excluding such party’s oral statements.”
  7. But always remember to properly place your no reliance clause so that it is coming from the perspective of the buyer, not the seller. Almost all of the recent agreements appear to have properly placed the no reliance clauses. See Glenn West, The Surprising Connection Between an Extra-Contractual Fraud Claim and a Flesh-Eating Zombie, Weil Insights, Weil’s Global Private Equity Watch, March 3, 2016, available here.
  8. See Glenn West, A New Reason for Private Equity Sellers to Hate Undefined “Fraud Carve-outs”, Weil Insights, Weil’s Global Private Equity Watch, May 16, 2017, available here; Glenn West, Icebergs in Your Contract—Undefined Fraud Carve-outs Continue to Produce Peril for Innocent Private Equity Sellers, Weil Insights, Weil’s Global Private Equity Watch, December 17, 2018, available here.
  9. See Glenn West, Too Much Dynamite—The Non-Recourse and Survival Clauses Are Both Subject to Delaware’s Built-In Fraud Carve-Out for Intentional Intra-Contractual Fraud, Weil’s Global Private Equity Watch, August 24, 2021, available here.
  10. Id.