One can expect that the structural vulnerabilities discussed above will become the subject of further attention in M&A agreements as the parties seek to address their impact on closing certainty.
Indemnification, Fraud, and Reliance Lessons
The dense, highly negotiated agreements used in mergers or acquisitions often require courts to decide which party better interprets technical provisions concerning their indemnification obligations or rights, and the ability of parties to assert fraud claims. The variations of nonreliance, integration, exclusive remedies, and indemnification clauses, and the way the clauses interact with each other and the public policies underlying fraud claims, lead to a seemingly endless variety of interpretation questions. Together the decisions guide sellers and buyers as to how to limit (or preserve) their indemnification obligations (or rights) and exposure to (or ability to assert) fraud claims.
Concerning fraud claims, the Delaware Court of Chancery decision in Online Healthnow, Inc. and Bertelsmann, Inc., v. CIP OCL Investments, LLC et al., analyzed how sellers can contractually seek to modify their exposure to post-closing fraud claims. Vice Chancellor Slights noted that they can do so in four ways: “(1) ‘what’ information the buyer is relying on, (2) ‘when’ the buyer may bring a claim, (3) ‘who’ among the sellers may be held liable, and (4) ‘how much’ the buyer may recover if it proves its claim.” The Vice Chancellor relied on what he described as the seminal decision in this area, Abry Partners V., L.P. v. F&W Acquisition LLC, to answer the “what” and “how much” questions, reiterating that parties may contractually disclaim reliance on extra-contractual statements, but may not contractually limit their liability for knowingly making false statements within the contract itself given Delaware’s “distaste for immunizing fraud.”
Vice Chancellor Slights then focused on the “when” and “who” questions in the case, analyzing an agreement that contained “remarkably robust survival, anti-reliance and non-recourse provisions that appear to atomize Plaintiffs’ claims across all of the recognized planes of contractual limitations.” Abry and its progeny make clear that “contractual limitations on liability are effective when used in measured doses,” but it would be “too much dynamite” to “invoke a clause in a contract allegedly procured by fraud to eviscerate a claim that the contract itself is an instrument of fraud.” That meant the survival provision could not cut off a claim for contractual fraud, and the non-recourse provision could not insulate a third party from liability if that party knew of and facilitated the fraudulent misrepresentations made in the acquisition agreement. On the specifics alleged, the plaintiff in Online Healthnow had adequately pled the parties knew of and facilitated the fraudulent misrepresentations through their participation in the sale process and drafting of the agreement.
Regarding indemnification and reliance cases, the number of cases discussing these points is such that a full discussion is beyond the scope of the CLE presentation or this summary. A number of those cases were thus discussed briefly, before using the recent Chancery decision in Spay Inc. v. Stack Media Inc., as a case study. There, the court largely denied a motion to dismiss because the purchase agreement did not bar the asserted claims. First, the court determined that the limitation on survival applicable to non-fundamental representations and warranties did not by its terms apply to covenants. Because the purchase agreement failed to specify a survival period applicable to covenants, the covenants survived until expiration of the applicable statute of limitations. Further, the survival period applicable to non-fundamental representations and warranties was not applicable where the claim for breach was based on fraud (which was not defined in the agreement). The exclusive remedy provision specifically stated that such fraud was not exclusively governed by the indemnification regime in the purchase agreement, meaning claims for breaches based on such fraud could still be brought after expiration of the contractual survival period. The court did not address, but referenced in dicta that the survival period for representations may not apply to the closing certificate unless expressly stated.
Beware the Boilerplate
Sample, model, or previously used agreements commonly serve as the starting point for drafting transactional documents. Using those provisions and treating them as boilerplate that does not require customization, however, may result in outcomes not considered by the parties. Recent decisions construing boilerplate provisions, and particularly those relating to governing law, exclusive forum, and jury trial waivers, should make practitioners consider whether to modify those provisions to better reflect the interests of their clients.
As Professor John Coyle of the University of North Carolina School of Law has observed, there is a secret language of choice-of-law and forum selection clauses. As a result, to ensure that the law chosen by the parties applies to not only resolution of any interpretive questions arising under the contract (i.e., ambiguities) but also determination of their substantive rights and obligations, parties should expressly state that the contract shall be “governed” (as opposed to interpreted or construed) by the laws of the specified jurisdiction. Similarly, if the parties’ intent is to have the specified “governing” law apply not just to contract claims but also to tort or statutory claims relating to the contract, then many jurisdictions (among them New York) require that they expressly say so; inclusion of the phrase “and claims relating to this agreement” should eliminate any doubt as to the parties’ intent (most courts view “arising out of” as too narrow in scope). And a majority of U.S. courts (New York and Delaware—but not California—among them) distinguish between substantive law and procedural law when interpreting choice of law provisions. Since statutes of limitation are generally considered procedural in nature, a clause that provides the contract is to be governed by the law of a specified state, without more, runs the risk of selecting only such state’s substantive, not its procedural, law, resulting in the statutes of limitation of the forum jurisdiction, not those of the specified governing jurisdiction, being applied. To avoid that result, parties’ governing law provision should contain the phrase “including those laws applicable to statute of limitations.”
Finally, a word or two about exclusive forum selection clauses. What if the parties desire all claims relating to an agreement to be litigated exclusively in a specified jurisdiction? Would the following accomplish that goal: “The sole and exclusive jurisdiction for any litigation for enforcement of this Agreement shall be in the courts of [X]”? The answer is no—“enforcement” merely applies to the obligations set forth in the contract. As is true with respect to governing law, if parties want to ensure that all claims are adjudicated in a specific jurisdiction, they should replace “litigation for enforcement” with “litigation related to this Agreement.” And parties need to recognize that courts will refuse to enforce forum selection clauses if they believe the chosen forum would not apply a constitutional or statutory right, or the benefit of a fundamental public policy to which a party is entitled.