One of the most important issues in the acquisition of a private company is whether an aggrieved buyer can make a fraud claim against the seller after closing based upon representations made outside the four corners of the acquisition agreement (“extra-contractual representations”). As one would expect, Delaware courts rely heavily on the language of the agreement to resolve this issue. Established precedent makes clear that “a standard integration clause[] without explicit anti-reliance representations . . . will not relieve a party of its . . . extra-contractual fraudulent representations.” FdG Logistics LLC v. A&R Logistics Holdings Inc., 131 A.3d 842, 859 (Del. Ch. 2016). Instead, the agreement must contain “language that . . . can be said to add up to a clear anti-reliance clause. . . .” Thus, parties to acquisition agreements would be well advised to take additional care when drafting and negotiating these provisions.
According to a 2017 Deal Study (which analyzed publicly available acquisition agreements for transactions for definitive agreements that involved private targets being acquired by public companies), 55 percent of private acquisition agreements completed in 2016 and the first half of 2017 contained an express non-reliance provision––a 15 percent increase from the same study conducted in 2014. This provision amounts to a representation by the buyer that it only relied on the representations expressly set forth in the acquisition agreement. If enforced, a clear non-reliance provision will prohibit a buyer from bringing a post-transaction fraud claim against the seller based on any extra-contractual representations.
Unlike other jurisdictions, the enforceability of a non-reliance provision is the subject of a considerable body of case law in Delaware. These cases establish that acquisition agreements “without explicit anti-reliance representations” will not bar a claim for fraud. Abry Partners V, L.P. v. F & W Acquisition LLC, 891 A.2d 1032, 1059 (Del. Ch. 2006). Instead, the agreement must include “language that . . . can be said to add up to a clear anti-reliance clause by which the [buyer] has contractually promised that it did not rely upon [extra-contractual representations in executing the agreement].” This approach properly balances the law’s abhorrence of fraud and the strong tradition of freedom of contract under Delaware law.
In light of these policies, Delaware courts strictly construe non-reliance provisions when determining whether the provision bars a fraud claim for extra-contractual representations. While Delaware law does not require the use of specific language (i.e. “Magic Words”), the non-reliance provision must come from the buyer’s point of view to ensure the preclusion of fraud claims for extra-contractual representations. In other words, the buyer must clearly acknowledge that it did not rely upon extra-contractual representations in executing the agreement. Yet, as explained in Prairie Capital,[1] the provision does not have to be "framed negatively" in terms of what the buyer did not rely on; it is sufficient if the provision states affirmatively what the buyer did rely on. Prairie Capital III, L.P. v. Double E Holding Corp, 132 A.3d 35, 51 (Del. Ch. 2015.)
The FdG Logistics opinion is illustrative of a situation where the seller failed to shield itself from fraud claims based on extra-contractual representations because the provision was written from the perspective of the seller—not the buyer.
In FdG Logistics the non-reliance provision was formulated solely as a limitation on the seller’s representations and warranties, specifying that the seller had not made any representation and warranties other than those expressly set forth in the agreement. Accordingly, the Chancery Court found the language insufficient to bar the buyer’s fraud claims based on extra-contractual representations made during the negotiation and diligence process. The Court explained that, in balancing the imperatives of holding sophisticated parties to the terms of their contacts and of protecting against the abuses of fraud, “the court will not insulate a party from liability for its counterparty’s reliance on fraudulent statements made outside of an agreement absent a clear statement by that counterparty—that is, the one who is seeking to rely on extra-contractual statements—disclaiming that reliance.”
The following text, which is not a substitute for obtaining legal counsel, demonstrates how to draft language to avoid the result reached in FdG Logistics:
No Other Representations and Non-Reliance. Except as expressly set forth in Article [ ], neither Seller nor any of Seller’s agents, employees or representatives have made, nor are any of them making any representation or warranty, express or implied, in respect of the Seller or the Seller’s business, and any other representations or warranties are hereby expressly disclaimed. Buyer expressly acknowledges and agrees that neither Buyer nor any of Buyer’s agents, employees or representatives is relying on any other representation or warranty of Seller or any of its agents, employees or representatives, including the accuracy or completeness of any other representations and warranties, whether express or implied, except as expressly set forth in Article [ ].
To further protect the seller against a post-closing fraud claim based on extra-contractual representations, in addition to the non-reliance provision above, the agreement should include an integration clause. An integration clause amounts to a representation that the agreement constitutes the entire agreement between the parties and supersedes any prior understandings or representations by the parties. Integration clauses serve to help eliminate any potential ambiguity about the agreement’s scope—including the nature and extent of the parties’ representations and warranties as well as any agreements, conditions, remedies, and qualifications—by defining and limiting the universe of information constituting the deal terms. An example of such provision is provided below.
Integration. This Agreement (including the Exhibits and Schedules hereto), the Ancillary Agreements and the Confidentiality Agreement constitute the entire understanding and agreement, and supersede all prior written agreements, arrangements, communications and understandings and all prior and contemporaneous oral agreements, arrangements, communications and understandings between the parties with respect to the subject matter hereof and thereof.
Because of the increased use of non-reliance provisions in private acquisitions, it is imperative that lawyers understand how these provisions interact with a standard integration clause to limit fraud liability. The purpose of a non-reliance provision is to prevent the buyer from circumventing the limitations on the sellers’ negotiated indemnification obligations by bringing a claim for fraud based on extra-contractual representations, while an integration clause serves to limit the universe of information constituting the deal terms. As this Article illustrates, a standard integration clause without an explicit anti-reliance provision is insufficient. Instead, the agreement must acknowledge that the buyer did not rely on any extra-contractual representations in entering into the transaction. Failure to incorporate language to that effect could result in significant unintended liability for your client.
[1] Prairie Capital III, L.P. v. Double E Holding Corp., 132 A.3d 35, 51 (Del. Ch. 2015).