Dodd-Frank.com

“Too Much Dynamite” Can Override Indemnification Limitations

By | August 16, 2021

Online Healthnow, Inc. et al v. CIP OCL Investments, LLC et al considers whether certain indemnification limits violate the public policy of the State of Delaware.

The opinion begins with the following passages:

In a scene from the classic film Butch Cassidy and the Sundance Kid, the scofflaw protagonists are frustrated in their attempts to gain entry into a cash-filled train car as they attempt to rob it. In his frustration, Butch resorts to a heavy dose of dynamite, apparently too heavy. On detonation, the entire train car, and its contents, are blown to bits. As the ash from incinerated currency rains down, Sundance turns to Butch and asks sarcastically, “Think you used enough dynamite there, Butch?”

The issue addressed in this opinion is whether, in the context of an acquisition agreement, Delaware courts should enforce broad contractual limitations on the right of contracting parties to bring post-closing claims that are so potent they effectively eviscerate all claims, including those that allege the contract itself is an instrument of fraud. In other words, can parties to a contract, by their agreement, detonate all bona fide contractual fraud claims (discovered or undiscovered) with the stroke of their pens at the closing table . . .

For reasons explained below, Defendants’ motion to dismiss must be denied. Under Delaware law, a party cannot invoke provisions of a contract it knew to be an instrument of fraud as a means to avoid a claim grounded in that very same contractual fraud. Stated more vividly, while contractual limitations on liability are effective when used in measured doses, the Court cannot sit idly by at the pleading stage while a party alleged to have lied in a contract uses that same contract to detonate the counter-party’s contractual fraud claim. That’s too much dynamite.

The case involved an acquisition.  Seller and its affiliates apparently discovered during the course of the auction that target’s computer systems did not properly account for state sales taxes due for sales.  Seller and its affiliates did not advise the ultimate buyer of this fact and buyer alleged the representation in the Stock Purchase Agreement were made with knowing falsity on behalf of the Seller and the other Defendants.

Defendants contended that the survival clause expressly provided that the representations and warranties terminated upon closing, and therefore any claim (including a fraud claim) arising from those reps and warranties was extinguished when the deal closed. Second, Defendants contend even if the Court found the limitations clause did not bar Plaintiffs’ fraud claim altogether, the SPA’s anti-reliance and non-recourse provisions work together to bar Plaintiffs’ fraud claim.

The Court ultimately held that based on the weight of authority, and Delaware’s public policy, the SPA’s survival clause cannot, and does not, defeat Plaintiffs’ contractual fraud claims. The Court noted that the clause served its purpose—there can be no post-closing claim for breach of a warranty that did not survive closing. But the Sellers cannot invoke a clause in a contract allegedly procured by fraud to eviscerate a claim that the contract itself is an instrument of fraud.

Defendants also contended that CIP Capital, which controlled the Seller, and the other Defendants could not be held liable for Seller’s contractual representations under the SPA’s non-recourse and anti-reliance clauses. Plaintiffs responded that it expressly relied on the allegedly fraudulent misrepresentations made by Seller, and the Seminal Delaware case ABRY Partners does not permit CIP Capital to take cover behind a non-recourse provision if it knowingly participated in the alleged contractual fraud.

The Court followed the holding in ABRY Partners which noted “that the public policy of this State will not permit the Seller to insulate itself from [liability or] the possibility that the sale would be rescinded if the Buyer can show . . . that the Seller knew that the Company’s contractual representations and warranties were false.” Because Plaintiff had well pled that CIP Capital did, in fact, know of and facilitate the fraudulent misrepresentations in the SPA through its participation in the sale, the Court held CIP Capital cannot invoke the non-recourse provision to avoid liability under ABRY Partners and its progeny.

Contact Steve Quinlivan for more information.

Topics: 
Litigation, M&A