By, Michael Farhang, Esq., former Federal Prosecutor and a Partner in the Los Angeles office of Gibson, Dunn & Crutcher.
The recent Delaware Court of Chancery decision in Sparton v. O’Neil reinforced a line of Delaware precedent holding that anti-reliance disclaimers in merger agreements can be used to defeat subsequent buyer claims for intentional fraud outside of the four corners of the contract.
In Sparton, the buyer sued certain stockholders and optionholders of the seller for fraud and breach of contract, alleging the sellers had presented fabricated financial statements in order to induce buyer to purchase seller for an inflated purchased price of $55 million.
After the deal closed, buyer discovered it was entitled to a working capital adjustment of approximately $2.5 million, well in excess of the $750,000 working capital adjustment cap.
The merger agreement contained a specific anti-reliance provision applying to extra-contractual representations.
The court ruled against the buyer’s fraudulent inducement claim on two principal grounds. First, the court held that buyer’s allegations of fraud relating to the financial statements fell short of particularized pleading requirements.
The court further held that buyer could not premise its fraud claim on any alleged conduct or statements by sellers encouraging them to rely on purportedly manipulated books and records. The court concluded that by virtue of the disclaimer, buyer agreed it did not rely on anything not contained in the merger agreement.
The specificity and breadth of the disclaimer provision in Sparton was likely a strong influence on the court’s holding. The provision was a highly specific disclaimer of the accuracy or completeness of any representations made outside the written contract and an agreement not to rely on them.
The result in Sparton is a cautionary example for buyers given that, according to the allegations of the complaint, it’s unclear how a similar buyer could have been expected to independently discover the alleged fraud in order to adequately protect itself.
Interestingly, some other jurisdictions might have offered the buyer greater protection under similar circumstances. California, for example, renders disclaimers that purport to apply to fraudulent conduct void and unenforceable.
Sparton counsels a strong warning to prospective buyers regarding specific anti-reliance disclaimers in agreements governed by Delaware law, as such provisions should be considered carefully and with a full awareness of their likely scope and preclusive effect in the event of a later claim that the seller induced the agreement through fraud outside of the written agreement itself.