Commercial parties who undertake the arduous process of negotiating and documenting the sale of an important commercial asset typically wish to protect themselves from the possibility that the transaction may be rescinded by the buyer alleging a claim of fraud in the inducement. Recent decisions from the Court of Chancery of the State of Delaware1suggest that sellers should be able to insulate their transactions from the possibility of rescission in all but the narrowest of circumstances. The following basic overview is intended to introduce certain components of a protective framework to counsel who do not regularly negotiate acquisition transactions.
A critical component of such a framework is the identification of the universe of information that constitutes the parties' agreement. This can be accomplished in the introductory paragraph and definitions section, but it is also important to include an integration clause and to understand what that clause adds to the agreement. In its simplest form, an integration clause states that the only terms the parties have agreed upon are those memorialized in the parties' written agreement, and that those written terms supersede all prior or contemporaneous representations or understandings.2Although parties have relied upon integration clauses to fulfill broader roles at times, the Court has recently construed these clauses narrowly.3In this context, an integration clause is best used as a tool to prevent a party's later attempt to alter the terms of its bargain through the introduction of extrinsic evidence.4
A non-reliance clause is an important companion to the integration clause. In its simplest form, a non-reliance clause states that the parties did not rely upon any representation of fact beyond those expressly recorded in the parties' agreement when entering into the contract.5Delaware courts will enforce these disclaimers of reliance against the parties who agree to them.6A non-reliance clause will protect the parties to the agreement from any later claim for legal or equitable relief based upon an alleged misrepresentation of fact that is not contained within the parties' agreement.7If the provision is clearly and simply stated, it will permit any such claims to be dismissed at the pleadings stage.8
When used together, integration and anti-reliance clauses allow contracting parties to specify with precision the factual representations for which they may be held to account, namely, those memorialized in the body of the agreement. Although these integration and anti-reliance clauses may be stated simply, they should not be inserted into a draft as boilerplate or accepted mindlessly. Sellers must make sure that the terms will provide the protection they expect9 , and buyers must understand their burden to ensure that all important representations of fact are included in the agreement.10
Even with respect to representations reduced to writing in the contract itself, however, acquisition agreements commonly include exclusive remedy provisions that detail the precise remedies that parties may seek in the event of a breach. For example, parties on the sell-side of an acquisition agreement typically prohibit those on the buy-side from seeking rescission of the contract in the event that one of the seller's representations turns out to be false.11Instead, buyers are asked to accept indemnity provisions, designed to limit their remedy for such breaches to damages up to a negotiated limit.12In exchange, the buyers are ensured that the funds to satisfy any damages award will be available, as the seller will place the full amount of the indemnity fund in escrow.13The Court of Chancery recently considered the enforceability of a negotiated indemnity structure in the face of a buyer's claim of fraudulent inducement.
In ABRY Partners V, L.P. v. F&W Acquisition LLC , the purchaser of a business sued to rescind the parties' purchase agreement based upon the sellers' alleged intentional and negligent misrepresentations.14The sellers moved to dismiss the buyer's claims on the ground that the buyer had waived its right to seek rescission under the parties' indemnity provisions and had instead agreed that its remedy would be limited to an arbitration award of damages up to $20 million.15The buyer, however, contended that the exclusive remedy provision was unenforceable on public policy grounds because it was tantamount to allowing a party to exculpate itself for fraud.16
The Court concluded that exclusive remedy provisions are not void under Delaware law in all circumstances, but that such provisions will not be enforced where a party was induced to enter into the agreement by another's intentional misrepresentations of fact.
[W]hen a seller intentionally misrepresents a fact embodied in a contract - that is, when a seller lies - public policy will not permit a contractual provision to limit the remedy of the buyer to a capped damage claim. Rather, the buyer is free to press a claim for rescission or for full compensatory damages.17
Thus, the Court concluded that if the buyer were able to prove that the sellers intentionally misstated or concealed a fact with knowledge of its falsity, the purchase agreement's indemnity provisions would not prevent the Court from rescinding the contract.18
With respect to non-intentional misrepresentations of fact, however, the Court held that the parties had significantly more flexibility to bind themselves to exclusive remedy provisions.19Because unintentional misrepresentations, whether innocently, negligently or recklessly made, are of a different moral and practical character than knowing misrepresentations,20the Court concluded that the law should treat such misrepresentations differently.
[T]he Buyer may not escape the contractual limitations on liability by attempting to show that the Seller acted in a reckless, grossly negligent or negligent manner. The Buyer knowingly accepted the risk that the Seller would act with inadequate deliberation.21
The Court concluded that the level of investigation that a buyer may expect from a seller respecting its representations of fact in a contract is an appropriate subject for bargaining between the parties22and that when parties agree to allocate the risks associated with their imperfect knowledge in a specific manner, the Court may enforce the agreement to the extent that it was not induced by actual fraud.23
Should future sellers and their counsel conclude from the brief overview above that they may safely copy the indemnity provisions from ABRY Partners - or any of the other provisions cited - into their acquisition agreements? This would not appear advisable, at least without subsequent discussions with the buyer. One theme running throughout the Court's opinions in this area of the law is the importance of vigorous negotiation and careful drafting of all terms in parties' remedy-limiting structures. Thus, it is not clear that the ABRY Partners ' indemnity provisions would be enforced if a seller were to adopt the provisions' language wholesale, and the buyer were to return the proposed draft with very minor revisions.
The result may depend upon the relative sophistication of the parties.24Several cases have highlighted the sophistication of the parties and their actual negotiations of contract terms as a rationale for enforcing those terms.25The extent of negotiation that a court will look for in any particular circumstance, however, and whether that amount may vary inversely with the sophistication of the parties, remains to be addressed in future decisions.
As the law continues to develop, however, it appears that counsel can garner the greatest protection for their clients' transactions by articulating completely their clients' needs and expectations to other negotiating parties and, if an agreement is reached, memorializing the parties' bargain thoroughly and carefully in the final contract.26
Published December 1, 2006.
