Type: Law Bulletins
Date: 01/26/2022

Beware of Undisclosed Advancement Obligations

On Jan. 19, 2022, the Delaware Chancery Court ruled on a thorny issue relating to a buyer’s obligation to advance a seller’s legal fees in a post-close dispute. The court held the buyer must advance the seller’s legal fees, notwithstanding that the seller allegedly and fraudulently failed to disclose the existence of those advancement rights during the sale process.

In Agspring Holdco, LLC v. NGP X US Holdings LP, (Del. Ch. Jan. 19. 2022), seller NGP sold its interest in Agspring to the buyer pursuant to a membership interest purchase agreement. NGP and Agspring had entered into a services agreement years earlier when NGP formed Agspring. The services agreement required Agspring to advance legal fees and costs to NGP in the event of a future dispute. After the buyer acquired Agspring, the buyer discovered seller NGP’s fraudulent misrepresentations. The buyer sued seller NGP in Delaware Chancery Court. Seller NGP immediately disclosed and sought advancement rights, requiring Agspring to pay its defense costs and fees in the post-close dispute.

The buyer claimed seller NGP never disclosed the advancement obligation and amended its complaint to add that additional fraud claim. The buyer alleged that the seller knowingly made false misrepresentations about the underlying deal and fraudulently omitted the existence of the advancement obligation during due diligence. The buyer also argued that Agspring could not afford to pay seller NGP’s legal fees. The buyer claimed Agspring was insolvent and paying those fees would put Agspring into default.

The court held that Agspring had to advance seller NGP’s legal fees and expenses. The court rejected the buyer’s insolvency defense – “severe financial hardship . . . is not a legally cognizable defense to advancement.” The court found nothing in the purchase agreement nullifying the service agreement’s advancement provision. The court sympathized with the buyer’s plight but concluded that the buyer could potentially recoup the advancement monies if it was successful on the underlying fraud claim against the seller. The parties have not yet begun discovery and are likely years from a judgment. To succeed, the buyer will likely have to pay millions of dollars both for its own legal fees and the seller’s legal defense costs.

Key Takeaways

Buyers should insist on full disclosure of a seller’s advancement and indemnification rights. If a seller denies the existence of advancement or indemnification rights, write that representation directly into the purchase agreement. The parties should explicitly agree that the purchase agreement nullifies and supersedes any previous advancement rights. If the seller discloses an advancement right, the buyer should add it to the negotiations. Determine whether the seller will abandon its right to advancement for fraud and misrepresentation.

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