Effective Non-Reliance Provisions Must be Drafted with Precision in Delaware
In almost every agreement for the sale of a company, regardless of whether it is an asset sale, stock purchase or merger, there will be provisions limiting the representations to those made within the four corners of the agreement. Such provisions are commonly titled “No Other Representations” and frequently resemble language such as this: “Except as set forth in this Article, the Company makes no other representations or warranties, directly or indirectly, and any such other representation or warranty is hereby disclaimed.” By including this provision, sellers seek to limit liability for extra-contractual claims based on fraud or other alleged misrepresentations during the due diligence and negotiation process. However, recent case law in Delaware provides that the foregoing disclaimer by the selling party is not enough to avoid a claim for extra-contractual liability. The counterpart to the No Other Representations language is an affirmative non-reliance provision which states that the purchaser is not relying on any statements or representations of the seller other than those expressly set forth in the agreement. The Delaware Chancery Court (the Court) recently reaffirmed that the seller’s disclaimer alone is insufficient to limit liability and that an aggrieved party will only be prevented from asserting fraud claims based on extra-contractual representations if such party has made an unambiguous affirmative disclaimer of reliance on such statements. See FdG Logistics LLC v. A&R Logistics Holdings, Inc. (Del. Ch. 2016).
The dispute in FdG Logistics arose out of a 2012 transaction in which the sellers of a trucking company entered into negotiations with a private equity firm for sale of the company through a merger agreement (the Merger Agreement). After closing the merger, the sellers brought a suit against the purchaser and the purchaser asserted several counterclaims. These counterclaims included a claim for common law fraud based on alleged misrepresentations made by the sellers in pre-merger materials, including a confidential information memorandum and a management presentation. The common law fraud claim was important to the purchasers because the Merger Agreement also included a typical cap on indemnification liability, with a customary carve-out for fraud or intentional breach. The sellers sought to have the fraud claim dismissed on the grounds that it was based on extra-contractual statements made to the purchaser before it entered into the Merger Agreement.
Specifically, the sellers argued that the purchaser was barred from establishing that it justifiably relied on representations made in the pre-merger materials due to two sections in the Merger Agreement: (1) a disclaimer in the sellers’ representations and warranties section stating that the sellers made no representations or warranties outside the Merger Agreement; and (2) an integration clause stating that the Merger Agreement “contain[s] the entire agreement between the [p]arties and supersedes any prior understandings, agreements or representations by or between the [p]arties.” The Court held that the integration clause in the agreement “merely states in general terms that the merger agreement constitutes the entire agreement between the parties and does not contain an unambiguous statement by buyer disclaiming reliance on extra-contractual statements.” Further, the Court held that because the relevant provisions of the Merger Agreement did not contain an explicit unambiguous anti-reliance disclaimer, the purchaser would not be precluded from asserting a claim for fraud based on representations outside the four corners of the Merger Agreement.
The Delaware Chancery Court’s decision in FdG Logistics reaffirms an earlier decision in Abry Partners V, L.P. v. F & W Acquisition LLC, 891 A.2d 1032 (Del. Ch. 2006), where the Court explained that an appropriate balance must be struck between holding sophisticated parties to the terms of their contracts and protecting against the abuses of fraud. The Court in Abry emphasized that it would not insulate a party from liability for an aggrieved counterparty’s reliance on fraudulent extra-contractual statements absent a clear statement by the counterparty disclaiming such reliance. The Court also addressed this issue in Anvil Holding Corporation v. Iron Acquisition Company, Inc., 2013 WL 2249655 (Del. Ch. 2013), where the purchase agreement contained similar disclaimers of representations by the target company and the sellers as well as an integration clause. In Anvil, the Court refused to dismiss the buyer’s fraud claims based upon extra-contractual representations stating that because the provisions in the agreement were not expressed from the point of view of the buyer, they did not reflect buyer’s promise that it was not relying on representations outside of the agreement in making its decision to enter into the agreement.
Under Delaware law, based on the precedent set in Abry and its progeny, effective non-reliance provisions must be carefully drafted with precision. The key to an effective non-reliance provision is that there is an affirmative unambiguous statement by the aggrieved party acknowledging and agreeing that it is not relying on any representations outside the agreement. The statement must have been made by the aggrieved party so that there is a clear promise by such party not to assert a claim based on extra-contractual representations. While there is no “magic” language according to the Court for a non-reliance provision, parties intending to limit representations to the four corners of an agreement should understand that an integration clause merely stating in general terms that the agreement constitutes the entire agreement between the parties and a “naked” disclaimer by the party making the representations is ineffective in and of itself. Rather, the provision must be accompanied by an affirmative statement of non-reliance by the aggrieved party for whose benefit the representations are being made.
For questions or additional information on this matter, please contact Lori Smith (email@example.com; 212.714.3075), Ryan Udell (firstname.lastname@example.org; 215.864.7152), Bridget Henwood (email@example.com; 212.631.4421), Michael Psathas (firstname.lastname@example.org; 212-868-4833), or another member of our Corporate and Securities Group.