Nonparty Liability for Participating in the Conveyance of Knowing Falsehoods in the Express Representations and Warranties in an Agreement

This article is Part IV in the Many Splendors of Fraud Claims series by Glenn D. West, which explores recent cases that affect drafting practices for avoiding fraud claims in private company M&A.

In Delaware, as in most states,

any person or entity that is alleged to have knowingly participated in the making of a fraudulent misrepresentation can be liable for that misrepresentation to the same extent as the person or entity that actually makes the misrepresentation; and the persons or entities potentially liable can include affiliates of the entity making the representation, as well as the human officers and owners of that entity or its affiliates, to the extent they knowingly cause or permit that entity to make a fraudulent misrepresentation.

This concept applies to both intra-contractual and extra-contractual fraud claims.

Importantly, however, ABRY Partners V, L.P. v. F & W Acquisition LLC and its progeny permit (1) extra-contractual fraud to be taken off the table for both parties and nonparties to an agreement, through a properly worded disclaimer-of-reliance provision (to which the nonparties are made third-party beneficiaries); (2) liability for intra-contractual fraud to be limited to deliberate or knowing falsehoods stated in the express representations and warranties contained in the written agreement only, through an exclusive remedy provision (to which the nonparties are made third-party beneficiaries); and (3) the elimination of liability, through an exclusive remedy and nonrecourse provision, for parties and nonparties from “reckless, grossly negligent, negligent, or innocent misrepresentations of fact” in a purchase agreement (all of which are potential states of mind supporting tort-based claims, including, potentially, common-law or equitable fraud).

What no contractual provision can accomplish, however, whether it is an exclusive remedy provision or a nonrecourse provision, is the elimination of liability of either a party or a nonparty for knowingly making or causing another person to make a deliberately false statement in a purchase agreement. I have written about this several times, but it appears that deal lawyers continue to negotiate fraud definitions and nonrecourse provisions as if nonparties could avoid liability for deliberate and knowing participation in the conveyance of falsehoods in the express representations in a purchase agreement.

Matrix Parent: Deficient Fraud Definition

Fraud is frequently defined with the aim of purportedly limiting liability for fraud to only the party that is actually making the representations and warranties in the purchase agreement. An example of this approach is the following definition of Fraud from the recent Delaware Superior Court decision Matrix Parent, Inc. v. Audax Management Company, LLC:

[“Fraud” means] intentional and knowing common law fraud under Delaware law in the representations and warranties set forth in this Agreement, any Contribution Agreement and the certificates delivered pursuant to Section 2.02(f)(i) and Section 2.03(d)(i). A claim for Fraud may only be made against the Party committing such Fraud. “Fraud” does not include equitable fraud, constructive fraud, promissory fraud, unfair dealings fraud, unjust enrichment, or any torts (including fraud) or other claim based on negligence or recklessness (including based on constructive knowledge or negligent misrepresentation) or any other equitable claim.

But as noted by Aveanna Healthcare, LLC v. Epic/Freedom, LLC, one of ABRY Partners’ many progeny, “if a seller ‘knew that the company’s contractual representations were false,’ the seller cannot ‘insulate’ itself from contractual fraud by hiding behind the company’s representations.” In other words, it does not matter who technically made the representations—it matters who participated in their making or in causing them to be made.

And just as nonparties cannot hide behind the party that technically made the contractual representations, you cannot use a nonrecourse provision to exonerate nonparties from their participation in the conveyance of intentional lies in a written purchase agreement either. Nonrecourse provisions are not permitted to go so far—any attempt to do so is famously considered “too much dynamite.”

Matrix Parent not only rejected the effort of defendants to limit Fraud, as it was defined, to just the parties to the purchase agreement, but also rejected the reliance upon a very broadly worded nonrecourse clause to exonerate nonparties who were alleged to have knowingly participated in intentional intra-contractual fraud. The court further rejected a very explicit provision that actually had the parties waiving “any claim against any Non-Recourse Party for conspiracy, aiding or abetting or other theory of liability.” According to the court, “under Delaware law, the terms of a fraudulently procured contract [even though limited to claims based ‘solely on the falsity of express contractual representations’] cannot exempt from liability entities that were knowingly complicit in the fraud, including entities that aided, abetted, or conspired to commit such fraud.” And, similar to the holding in Online Healthnow, Inc. v. CIP OCL Investments, LLC, “[b]ecause Plaintiff has well pled that [a non-recourse party] did, in fact, know of and facilitate the fraudulent misrepresentations in the SPA . . . [the non-recourse party] cannot invoke the non-recourse provision to avoid liability under ABRY Partners and its progeny.”

Crafting an Agreement with the Matrix Parent Decision in Mind

So, knowing this, you can easily agree as a seller to carve out intentional inter-contractual fraud from the nonrecourse clause, and define Fraud by reference to “Persons” rather than “Parties.”

The July 15, 2024, Merger Agreement governing Perdoceo Education Corporation’s $135 million acquisition of University of St. Augustine for Health Sciences, LLC, contains an example of a Fraud definition that appears to understand that you cannot limit intentional intra-contractual common-law fraud to just the party actually making those representations:

“Fraud” means actual and intentional common law fraud under Delaware law with respect to the representations and warranties set forth in this Agreement (including Article V or Article VI), any of the Related Documents, or any certificate delivered pursuant to this Agreement or any of the Related Documents. For the avoidance of doubt, (a) the term “Fraud” does not include any claim for equitable fraud, promissory fraud, or unfair dealings fraud, or any claim for fraud or misrepresentation based on negligence or recklessness and (b) only a Person who had actual knowledge of or knowingly and intentionally participated in such Fraud shall be responsible for such Fraud and only to a Person who actually relied on such representations and warranties and was actually damaged or harmed by such Fraud.

Keep in mind that clause (b) does not actually do anything that the law of Delaware doesn’t already do, but sometimes saying it out loud helps the other side—and it’s sleeves off the seller’s vest to acknowledge that nonparties can be liable for the knowing participation in the conveyance of falsehoods in the express representations and warranties set forth in an acquisition agreement.