Type: Law Bulletins
Date: 02/04/2022

Clarifying Delaware's "Muddled" Anti-Bootstrapping Rule

This week, the Delaware Chancery Court clarified the “muddled” state of Delaware law on the anti-bootstrapping rule. That rule generally prevents plaintiffs from contemporaneously asserting fraud and breach of contract claims. The court held both claims can be brought against a party “who knew contractual representations were false, and yet made them anyway.”

Plaintiffs in Levy Family Investors, LLC v. Oars + Alps LLC, (Del. Ch. Jan. 27, 2022), were early investors and convertible noteholders of Oars + Alps. Plaintiffs’ convertible notes empowered them to block the company’s founders from selling more than 5% of the company without plaintiffs’ approval.

Buyer S.C. Johnson & Son, Inc. entered into discussions with founders to buy a majority stake in Oars + Alps. A confidentiality agreement prevented founders from sharing the purchase agreement with plaintiffs. Plaintiffs threatened to block the transaction without knowing the deal’s terms. So, founders made various written representations, promising plaintiffs that they would both receive the same price ($5.0815/share) for their interests “at closing.” With that promise in hand, plaintiffs approved the deal.

A year later, plaintiffs discovered in a news article that S.C. Johnson actually bought additional Oars + Alps equity at $11.79/share from founders immediately “following the closing” as part of the same purchase agreement. Plaintiffs sued founders for both fraud and breach of contract.

Founders moved to dismiss plaintiffs’ complaint, arguing its representations to plaintiffs were all technically true and that plaintiffs’ complaint ran afoul of the anti-bootstrapping rule. The court rejected both arguments. The court had little patience for founders’ technical arguments on the specific representations, finding plaintiffs were induced to sell and had adequately alleged fraud. The court also summarized the “muddled” state of Delaware jurisprudence on the anti-bootstrapping rule. The court concluded that a plaintiff can plead a fraud claim that is not improperly bootstrapped to a breach-of-contract claim “by alleging facts that support an inference that the defendant knowingly made false representation in a contract on which the plaintiff justifiably relied, and then breached that contract by violating the representation(s) that were falsely made.”

Key Takeaways

  • Beware providing consent to deals when your client is in the dark. Insist upon full disclosure. But for the plaintiffs stumbling upon a news article a year after the deal, plaintiffs would have been out millions of dollars.
  • NDAs and confidentiality agreements are often too broad. Why would a buyer prevent a seller from sharing purchase agreement drafts with a party who can block the deal? The confidentiality agreement ended up costing the parties significant money and reputational damage.
  • Just because you can doesn’t mean you should. Founders in this case apparently tried to pull a fast-one on the plaintiffs. Plaintiffs let loose language slip through, and founders tried to take advantage. Delaware Chancery Courts are courts of equity. It is hard to see any scenario where the court would allow this wrong to stand.
  • In a post-close dispute involving fraud and contractual claims, plaintiffs should avoid merely adding the term “fraudulently induced” to a complaint or alleging that the defendant never intended to comply with the agreement. The court here gave future parties a roadmap for complying with the anti-bootstrapping rule – follow it.

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