How Well are Sellers Protected from Post-Closing Claims? The Answer May Depend on a Single Magic Word: “Completeness”
The formula for a well-written M&A agreement is quite simple: (i) a buyer bargains for certain representations and warranties (“reps and warranties”) about the target company and its business from the seller, (ii) the seller promises to indemnify the buyer for any losses caused by inaccurate reps and warranties, and (iii) the buyer bargains for a survival period. If the buyer discovers one of the reps and warranties was inaccurate when made, as long as the buyer brings her claims within the survival period, she may be able to seek contractual indemnification for her losses caused by that inaccurate rep or warranty.
The key to ensuring that parties get what they bargain for is to limit the types of claims a buyer can bring against a seller only to those reps and warranties expressed in the parties’ agreement.
This simple formula allows buyers and sellers to bargain for specific risk allocation choices. If, for example, a buyer is concerned that the seller’s operation of a manufacturing facility may have caused environmental liabilities for the target company, the buyer can ask the seller to represent that there are no conditions at the instant facility that are out of compliance with applicable environmental regulations.
The key to ensuring that parties get what they bargain for is to limit the types of claims a buyer can bring against a seller only to those reps and warranties expressed in the parties’ agreement. If, for example, a buyer asks a seller to give the compliance representation mentioned above, the seller might ask the buyer for some return consideration—either in the form of a price move or some corresponding, beneficial adjustment to the agreement. Through this “give and get” process, the parties arrive at an economically efficient allocation of risk.
This balance breaks down, however, if the buyer is unwilling to bargain for reps and warranties from a seller, but is permitted to bring common law fraud claims based upon representations outside of the parties’ agreement. From a seller’s perspective, a well-drafted M&A agreement will ask the buyer to promise that she is not relying upon any reps and warranties from seller other than those expressed in the parties’ agreement (a “non-reliance provision”). Courts have construed non-reliance provisions to knock out the “reasonable reliance” element of fraud.
In 2006, then-Vice Chancellor Strine of the Delaware Court of Chancery stated Delaware’s firm public policy of holding buyers to such promises, writing “Delaware law permits sophisticated commercial parties to craft contracts that insulate a seller from a recession claim for a contractual false statement of fact that was not intentionally made.” Abry P’rs V, L.P. v. F&W Acquisition LLC, 891 A.2d 1032, 1035 (Del. Ch. 2006). The court was clear in its guidance for buyers: “parties with free will should say no [to a non-reliance provision] rather than lie in a contract [by bringing a fraud claim based upon extra contractual reps and warranties].” Id. at 1058. Since the seminal Abry decision, Delaware courts have further-explained the interaction between fraud claims and contractual non-reliance provisions.
In 2013, then-Vice Chancellor Parsons issued a Memorandum Opinion in Transdigm Inc. v. Alcoa Global Fasteners, Inc., 2013 WL 2326881 (Del. Ch. May 29, 2013). In that case, buyers alleged, among other things, that sellers had fraudulently concealed certain negative developments in the target’s relationship with a key customer. Sellers pled around a contractual non-reliance provision by arguing that “Count II stems from TransDigm’s concealment of material information, not from any representation that TransDigm made outside the Purchase Agreement.” In other words, Alcoa argued it was not bringing a claim based upon its reliance on TransDigm’s affirmative misrepresentations, but based upon TransDigm’s acts of concealment, which put Alcoa off the trail of inquiry to discovering negative information.
The language at issue was Alcoa’s agreement to accept shares “without reliance upon any express or implied representations or warranties of any nature, whether in writing, orally or otherwise.” Vice Chancellor Parsons held the foregoing language did not bar Alcoa’s fraudulent concealment claim because “there is no argument  that Alcoa agreed . . . that TransDigm was making no representations to the ‘accuracy and completeness’ of the information TransDigm provided to Alcoa. Nor did Alcoa disclaim reliance on extra-contractual omissions.”
Other Delaware courts have distinguished and limited TransDigm’s holding. Wind Point Partners VII-A, L.P. v. Insight Equity A.P. X Company, LLC, 2020 WL 5054791 (Del. Super. Ct. Aug. 17, 2020) emphasized that a fraudulent concealment claim requires “an affirmative act of concealment must be adequately pled in the complaint.” So simply recasting a fraud claim by adding the word “concealment” will not suffice for dissatisfied buyers.
Further, Vice Chancellor Laster has persuasively questioned the fundamental premise of the fraudulent concealment work-around. He writes “The critical distinction [from Abry] is not between misrepresentations and omissions, but between information identified in the written agreement and information outside of it.” Prairie Capital III, L.P. v. Double E Holding Corp., 132 A.3d 35, 52 (Del. Ch. 2015). “When parties identify a universe of contractually operative representations in a written agreement, they must remain in that universe,” and “a party that is later disappointed with the written agreement cannot escape through a wormhole into an alternative universe of extra-contractual omissions.” Id. at 53. Stated differently, the means to prevent a seller from concealing material facts is to bargain for (and pay for) more fulsome reps and warranties—not to bring a fraudulent concealment claim.
Whether the TransDigm fraudulent concealment work-around remains viable or not, sellers are well-advised to require a buyer to disclaim reliance upon the “accuracy and completeness” of the seller’s reps and warranties.
Whether the TransDigm fraudulent concealment work-around remains viable or not, sellers are well-advised to require a buyer to disclaim reliance upon the “accuracy and completeness” of the seller’s reps and warranties. See Pilot Air Freight, LLC v. Manna Freight Sys., Inc., 2020 WL 5588671, at *21-22 (Del. Ch. Sept. 18, 2020) (holding that a non-reliance provision containing “completeness” was sufficient to bar fraudulent concealment claims). With this language in place, sellers can limit their liability significantly.