Private Equity

The mere allegation of fraud has the potential of wreaking havoc with the carefully negotiated limits on liability specifically set forth in private company acquisition agreements. This is particularly true for the private equity seller distributing the proceeds of a portfolio company sale to its limited partners in reliance upon those limits on post-closing liability. And the use of robust and properly placed anti-reliance clauses to limit the universe of purported representations as to which such fraud claims may be premised, as well as the use of exclusive remedy clauses to limit the types of fraud that may be asserted, and against whom such fraud claims may be made, are (or should be) well known in the sell-side private equity deal world.^[1] But litigation counsel for the buyer dissatisfied with the bargained-for limited recourse thereby contractually provided in the acquisition agreement seems to always find new sources of potential fraud liability to attempt to thwart those contractual limitations. Roma Landmark Theaters, LLC v. Cohen Exhibition Company LLC, 2020 WL 58165759 (Del. Ch. Sept. 30, 2020) provides the latest illustration of that phenomenon.

Roma Landmark Theaters involved a dispute over a post-closing purchase price adjustment. As is not uncommon, the acquisition agreement required the target to provide a Preliminary Closing Statement (prepared in “good faith” using the same methodology employed in the preparation of the target’s Interim Financial Statements) upon which the purchase price adjustment would be determined at closing, subject to a Final Closing Statement to be provided by the buyer after closing. To the extent there was a dispute regarding the Final Closing Statement, the parties agreed to submit that dispute to an independent accounting firm to resolve; and “the accounting firm’s determination was ‘conclusive and binding upon the parties’ and [was] ‘not subject . . . subject to appeal or further review.’” The sellers disputed the buyer’s Final Closing Statement and the parties submitted the dispute to an independent accounting firm. The accounting firm resolved that dispute largely in the sellers’ favor. But the buyer refused to abide by the accountant’s determination and the sellers then sought specific performance of the accounting award pursuant to the terms of the acquisition agreement. In response, the buyer counterclaimed for—you guessed it—fraud. And keep in mind that the purchase agreement specifically provided that “the representations and warranties terminated upon the closing and barred any recourse by the Buyer against the [sellers].” Moreover, there was a robust non-reliance clause that precluded reliance by the buyer upon any purported representation made by anyone that was not specifically set forth in the purchase agreement. In other words, this was a no-indemnity, walk-away transaction.

Delaware law allows fraud claims to be premised upon the written representations and warranties set forth in an acquisition agreement, even when contractual recourse respecting those representation and warranties may be precluded by the express terms of the acquisition agreement (and a non-reliance clause does nothing to interfere with that concept because unlike extra-contractual statements, reliance upon which is expressly disclaimed, contractual representations are specifically agreed to have in fact been relied upon).^[2] And the fact that the written representations set forth in the acquisition agreement may have been made by the target company, rather than the sellers, does not mean that the sellers do not have potential exposure for fraud claims premised upon those contractual representations and warranties made by the target company being sold by the sellers. If the buyer alleges facts that support the proposition that the sellers knew the contractual representations were false when made by the target, the buyer can maintain a claim against the sellers for fraud based upon the representations made by the target. Thus, as is not uncommon, the sellers made no financial statement representations in the purchase agreement, but the target did.

It should come as no surprise, therefore, that the buyer claimed that the representation made in the purchase agreement by the target regarding the Interim Financial Statements was false because it failed to include certain liabilities; and that the sellers were in a position to know of its falsity and therefore could potentially have actually known and be chargeable with its falsity. And because the Preliminary Closing Statement had been required to be based upon those Interim Financial Statements, the allegedly faulty Interim Financial Statements apparently negatively impacted the accuracy of the Preliminary Closing Statement and the basis upon which the independent accountants had presumably made their determination regarding the Final Closing Statement. What was surprising, however, was that the buyer went a step further and argued that, in the same way that the sellers’ alleged knowledge of the falsity of a contractual representation made by the target can expose the sellers to fraud liability, the sellers could also be exposed to contractual liability for the target’s alleged breach of its contractual obligation to prepare the Preliminary Closing Statement in good faith.

The court rejected this conflation of fraud liability premised upon the sellers’ alleged knowledge of a false contractual representation made by the target with contractual liability premised upon the sellers’ alleged knowledge that the target had breached its contractual obligation to prepare the Preliminary Closing Statement in good faith. According to the court, “[h]aving agreed that the [target] owed the obligation to prepare the Preliminary Closing Statement, Buyer cannot now argue that Sellers owed the contractual obligation to prepare and deliver the Preliminary Closing Statement pursuant to the Purchase Agreement with the attendant contractual liability for breach.”

But not satisfied with its claim for potential fraud liability regarding the Interim Financial Statements representation itself (which was apparently more limited that its claims respecting the preparation of the Preliminary Closing Statement), the buyer made one last effort to try and effectively make the Preliminary Closing Statement a representation and not just a contractual obligation. The court likewise rejected this claim noting, among other reasons, that the non-reliance clause specifically stated that the buyer was not relying upon any statement, representation or warranty by the sellers of the target except those specifically delineated in Articles III and IV of the acquisition agreement. The Preliminary Closing Statement was not referenced in either Article III or IV (which were apparently the only sections of the agreement containing any “representations and warranties”). The buyer then argued that Delaware does not permit parties to a contract to disclaim reliance on any document referenced in the contract. The court rejected this argument too, noting that Delaware only proclaims that “fraud claims based on false representations of fact made within the contract itself cannot be disclaimed.” Because there was no specific representation in the acquisition agreement regarding the Preliminary Closing Statement, reliance on it was effectively disclaimed through the non-reliance clause.

Hmmm . . .