Friday, March 10, 2017

J.R. Ewing -Types Continue to Vex Courts and Corporate Law

Since the dawn of our legal system, courts have had to deal with the problem of the sneaky contracting party (think: J.R. Ewing from tv's "Dallas" - or to cite a more recent example, Rumpelstiltskin from tv's "Once Upon a Time").  You know the type - someone who tricks another party into signing a contract - only after signing the contract does the other party learn further information which, had it been disclosed at the time, the other party never would have agreed to the deal terms in the contract.

On the one hand, courts like to uphold contracts freely entered into by parties which are otherwise legally enforceable.

On the other hand, courts hate to permit contracting parties to get away with fraud or otherwise sneaky behavior.

I've blogged about this issue before here when the Texas Supreme Court tackled the case of the stinky restaurant. In that case, the court came out on the side of the duped tenant whose landlord failed to disclose that the space they were renting smelled like sewer gas.

Two recent corporate law cases decided in Delaware Chancery Court highlight this ongoing tension.

In Prairie Capital III, L.P. v. Double E Holding Corp., the court considered a case in which a company was sold based in large part upon falsified monthly sales information created by the seller. Unfortunately for the buyer, the stock purchase agreement included two key provisions: (1) one in which the buyer confirmed that it was relying exclusively on its own due diligence and the seller's representations and warranties in the agreement itself, and (2) a standard integration provision in which the parties agreed that the stock purchase agreement was the entire agreement of the parties (i.e., there were no oral agreements, side deals, etc.). Fortunately for the buyer, the seller also breached some expressed representations and warranties in the agreement itself, so the buyer's case was able to proceed against the seller on other legal theories.  Nonetheless, the court concluded that so-called extra-contractual misrepresentations by the seller could not be the basis of a fraud claim by the buyer. In the court's view, the buyer had adequately disclaimed reliance on any such extra-contractual statements, even though the buyer did not use any particular "magic words" to do so.

In FdG Logistics LLC, v. A&R Logistics Holdings, Inc. the court considered a case with almost identical facts as the Prairie Capital case but reached the opposite result - the buyer was permitted to pursue fraud claims against the seller. In that case, the seller was alleged to have made extra-contractual misrepresentations (i.e., misrepresentations other than those explicitly set forth in the representations and warranties section of the purchase agreement) in documents provided to the buyer during the due diligence period before the merger agreement was signed. Even though the merger agreement in question included a statement from the seller that it was not making any representations or warranties other than those explicitly set forth in the agreement itself and there was a standard integration (entire agreement) provision, the court ruled that there was not a clear disclaimer of reliance by the buyer in the merger agreement. Without such a clear disclaimer of reliance by the buyer, the buyer's fraud claims could proceed. The court admitted that it was splitting hairs, noting that statement by the seller that it is exclusively making certain representations and a statement by the buyer that it is exclusively relying on such representations seem "like two sides of the same coin." Nonetheless, because courts hate to permit parties to get away with fraud, it will only find an adequate disclaimer of reliance by a victim when such disclaimer is crystal clear.

It is easy to see the tension at work in these types of case. Courts want to allow sophisticated and well represented parties to set the terms of their own deals - and tailor the scope of the relevant representations and warranties upon which the parties relied. That sort of flexibility keeps parties from endlessly claiming to have relied upon all sorts of statements made outside of the contract itself. On the other hand, courts don't like the idea of rewarding those who commit fraud for their dishonesty and underhanded tactics, such as failing to disclose material facts that fall outside the scope of the representations and warranties in the agreement itself but are nonetheless important to the other party.    

The takeaways here are fairly obvious:

  • If you are a buyer and you relied upon a particular piece of information received from the seller in making a decision to enter into a transaction, you'll want to have the agreement say so explicitly in the seller's representations and warranties in the agreement itself. Then, you won't have to worry about whether or not the court will tolerate extra-contractual misrepresentation or fraud by the other party in your particular case.
  • If you are a seller, and wish to minimize your exposure for alleged extra-contractual misrepresentations, you'll want to include an explicit disclaimer from the buyer of reliance on any other statements from the seller other than those in the agreement itself. And after FdG Logistics, we now know that such disclaimer should be written such that it reads as a statement from the buyer's perspective disclaiming reliance, not just a statement from the seller that it is not making any other representations or warranties.  And even though courts often claim they aren't looking for any particular "magic words," sellers should seek to include the magic words "disclaim reliance" on other statements of the seller or seller's representatives. PUTTING THE DISCLAIMER OF RELIANCE IN BOLD AND ALL CAPS IS ALSO A GOOD IDEA. 
But regardless of how carefully contracts are drafted by the parties, society will always have parties seeking to game the system by complying with the letter but not the spirit of agreements, and courts will have to decide whether to let them get away with those games or not.


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