One of the critical considerations private equity funds have in selling their portfolio companies is the limitation of their liability for indemnity obligations after the closing. Great care is taken to negotiate limitations on liability, often in the form of temporal limitations, hurdles and caps and limitations on the types of losses recoverable.
A customary exception to these limitations exists for fraud perpetrated by the private equity fund in the sale. When fraud is implicated, most purchase agreements allow an aggrieved buyer to pursue nearly unlimited remedies outside of the purchase agreement.
While such claims are rare, a recent Delaware Court of Chancery decision provides us guidance on how private equity funds can limit the risk of fraud claims.
In IAC Search, LLC v. Conversant LLC (f/k/a ValueClick Inc.), 2016 WL 6995363 (Del. Ch. Nov. 30, 2016), the purchaser in a $90 million acquisition claimed that the seller misrepresented certain financial earnings of one of the purchased companies. The buyer alleged that it was fraudulently induced to overpay for the target because the seller provided it with inaccurate financial documents in the electronic data room and made inaccurate statements in response to the buyer’s diligence requests. The definitive agreement provided that claims of fraud were not subject to the $8 million indemnity cap, thus possibly exposing the seller to substantial liability.
The seller argued that the buyer’s fraud claim was barred by the standard disclaimer of reliance statements made by the buyer in the purchase agreement. The Chancery Court ruled in favor of the seller and dismissed the buyer’s fraud claim on the grounds that the purchase agreement contained a valid disclaimer of reliance on the inaccurate documents and statements by the buyer. Specifically, Section 4.7 of the Purchase Agreement stated:
The Buyer is a sophisticated purchaser and has made its own independent investigation, review and analysis regarding the [transaction] . . . which investigation, review and analysis were conducted by the Buyer together with expert advisors, including legal counsel, that it has engaged for such purpose. The Buyer acknowledges that neither the Seller nor any of its Affiliates or Representatives is making, directly or indirectly, any representation or warranty with respect to any data rooms, management presentations, due diligence discussions, estimates, projections or forecasts involving the [transaction] . . .
The Chancery Court relied on recent Delaware case law to support its decision to dismiss the buyer’s fraud claim. In so doing, the court identified three important considerations when drafting disclaimers of reliance to permit them to defeat a claim for fraud:
- the non-reliance clause must contain clear and concise language stating the buyer did not rely on statements outside of the contract to determine whether to execute the contract;
- disclaimers are usually worded in the negative, but a disclaimer worded in the affirmative (i.e., the buyer relies on its own investigation) is just as effective; and
- the buyer must make the disclaimer of reliance. It is not enough for the seller to state it makes no further representations or warranties.
Lawyers representing private equity funds in sale transactions should consider this guidance in crafting and negotiating disclaimers of reliance to limit the specter of post-closing fraud claims.