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Rory K. Schneider is a Partner and Colin O. Lubelczyk is an Associate at Mayer Brown LLP. This post is based on a Mayer Brown memorandum by Mr. Schneider, Mr. Lubelczyk, Martha E. McGarry, Andrew J. Noreuil, and Camila Panama and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Are M&A Contract Clauses Value Relevant to Target and Bidder Shareholders? (discussed on the Forum here) by John C. Coates, IV, Darius Palia, and Ge Wu; Allocating Risk Through Contract: Evidence from M&A and Policy Implications (discussed on the Forum here) by John C. Coates, IV.
There are several contractual provisions that sellers often use to limit their liability for post-closing claims brought by a buyer in the context of a private company purchase agreement. Reliance disclaimers, non- survival of representations and warranties, exclusive remedy, and no-recourse provisions in their typical forms, however, only go so far in court. Even where there is no explicit carve-out for fraud claims, as a matter of “public policy,” Delaware courts have generally not enforced contract provisions that prevent a buyer from asserting fraud claims against sellers and/or their affiliates for making false representations and warranties or knowing that representations and warranties made by other seller parties were false.
A consequence of this judicial approach is that it has exposed limited partners and selling shareholders to derivative unjust enrichment claims, of which there have been an increasing number of cases over the last several years. These unjust enrichment claims have proven difficult to dismiss at the pleading stage, thereby exposing affiliates to precisely the type of protracted litigation that, in many cases, the contracting parties agreed that seller affiliates should not have to face. In light of this, sellers and their counsel should consider adding contractual language to specifically preclude unjust enrichment claims that are not dependent upon any proof of wrongdoing. The law in Delaware remains unsettled on the extent to which explicit protections against such claims would result in their prompt dismissal, but at the least, their inclusion may make buyers less apt to file the claims in the first place and make courts more willing to reject them.
Purchase agreements frequently contain provisions aimed at limiting a buyer’s ability to pursue legal claims post-closing, including—but not limited to—claims against affiliates of the seller who are not parties to the contract. Three of the most common such provisions are:
At their most seller-friendly, such provisions could, if applied strictly, preclude buyers from pursuing virtually any post-closing legal claims. However, litigation of post-closing claims persists for several reasons, as discussed below.
First, fraud claims are often expressly exempted from certain contractual limitations. Though fraud carve- out provisions often endeavour to define actionable fraud as narrowly as possible, they nonetheless provide buyers with an avenue to assert post-closing fraud claims in one form or another. For example, an exclusive remedy provision may apply “except in the case of fraud,” in which case a legal claim for damages beyond contractual indemnification can be maintained.
Second, Delaware courts generally decline to dismiss certain fraud claims even when they are barred
by the express terms of an agreement. In its seminal 2006 decision in ABRY Partners V, L.P. v. F&W Acquisition LLC, the Delaware Chancery Court held that “[t]o the extent that the [Agreement] purports to limit the Seller’s exposure for its own conscious participation in the communication of lies to the Buyer, it is invalid under the public policy of th[e] state.” 891 A.2d 1032 (Del. Ch. 2006). Since that 2006 case—which the Delaware Supreme Court adopted in its 2021 decision in Express Scripts, Inc. v. Bracket Holdings Corp.—Delaware courts have consistently refused to enforce contractual limitations that bar fraud claims based on knowingly false misrepresentations contained within a purchase agreement.
The upshot of the ABRY Partners doctrine is that, no matter the extent of contractual limitations on post- closing claims, fraud claims remain viable, provided the buyer can plausibly allege that the defendants knowingly made false representations and warranties, or knew that representations and warranties were false. This is not a particularly high bar given that all the buyer must do is allege facts making it “reasonably conceivable” that the defendants knew that their representations were false. See Online HealthNow, Inc. v. CIP OCL Investments, LLC, 2021 WL 3557857, at *10 (Del. Ch. Aug. 12, 2021). In short, post-closing fraud claims cannot be fully circumvented in Delaware, and as a result, buyers often make use of them.
The ever-present availability of fraud claims does more than just prevent parties from contractually insulating allegedly intentional wrongdoers from suit. One less-discussed consequence of the ABRY Partners doctrine is that it also frequently permits buyers to maintain unjust enrichment claims against “innocent” shareholders and other seller affiliates who are alleged to have benefitted from the sale but may have had no role in perpetrating the alleged fraud. This result is troublesome because it can lead to unsuspecting parties being dragged into protracted and expensive litigation from which the purchase agreement purports to insulate them.
In general, an unjust enrichment claim accuses the defendant of benefitting from wrongful conduct to the plaintiff’s detriment, but does not require the defendant to have participated in the wrongful conduct. While the existence of an express contract governing the subject matter of the claim typically precludes a party from asserting an unjust enrichment claim, there is a key exception to that rule: if the contract itself wrongdoing (as in the case of a fraudulent inducement claim based on false representations and warranties), the contract’s existence will not preclude unjust enrichment claims against beneficiaries of a transaction.
It has thus become common for buyers to invoke this exception and assert claims of unjust enrichment against a transaction’s beneficiaries alongside claims of fraud. To date, Delaware courts have proven hesitant to dismiss these claims at the pleading stage, which subjects shareholders and other seller affiliates to expensive and burdensome discovery, despite not being a party to the agreement and often having the expectation that their exposure to litigation is limited.
Sellers and their counsel should consider specifically addressing unjust enrichment and similar claims that can derive from allegations of fraud when negotiating limitations on post-closing claims. The Chancery Court has acknowledged the possibility that the terms of a contract might prohibit equitable unjust enrichment claims, but the court did not actually rule upon the issue in either instance. See Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLP, 2014 WL 6703980, at *25-28 (Del. Ch. Nov. 26, 2014); LVI Grp. Invs., LLC v. NCM Grp. Holdings, LLC, 2018 WL 1559936, at *17 (Del. Ch. Mar. 28, 2018). While the enforceability of such provisions is somewhat uncertain for now, it is reasonable to expect that the more explicit the contractual prohibition on equitable claims is, the more likely courts would be to deny such claims. Even if the court does not make a determination on the enforceability of such language, including an explicit disclaimer in the agreement would be expected to discourage at least some buyers from pursuing such claims.
Below in bold text are several suggested additions to sample contractual provisions that could help bolster a seller’s case for dismissal of post-closing unjust enrichment claims at the pleading stage:
