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Robert S. Reder, a Professor of the Practice of Law at Vanderbilt Law School, has been serving as a consulting attorney at Milbank, Tweed, Hadley & McCloy LLP since his retirement as a partner in April 2011.
One of the primary goals of a seller of a privately-held business--at least after getting the best purchase price that it can negotiate--is to limit its liability to the purchaser for post-closing claims. One method of achieving this goal is to require in the purchase agreement that the purchaser disclaim reliance on any representations or warranties made by the seller or any of its representatives except as expressly set forth in the agreement.
Recently, in TransDigm Inc. v. Alcoa Global Fasteners, Inc.1 Vice Chancellor Donald F. Parsons, Jr. of the Delaware Court of Chancery tackled a dispute over whether disclaimers in a purchase agreement were adequate to shield the seller from charges of fraud and concealment. In allowing at least one of the purchaser's claims to survive the seller's motion to dismiss, the Vice Chancellor provided a helpful analysis of fairly typical purchase agreement terms that dealmakers and their legal counsel should find useful.
On January 28, 2011, Alcoa Global Fasteners, Inc. entered into a stock purchase agreement providing for its acquisition of two indirect, wholly-owned subsidiaries of TransDigm Inc. (the Fastener Subsidiaries). The Fastener Subsidiaries are engaged in “the design, development, manufacture and distribution of fasteners, fastening systems, and bearings.” Alcoa completed the purchase on March 8, 2011.
After the closing, Alcoa learned of two developments which materially and adversely impacted the Fastener Subsidiaries' relations with a key customer. Alcoa believed that these developments were known to TransDigm before the stock purchase agreement was signed, but actively concealed from Alcoa during its due diligence investigation. Notably, however, Alcoa could not point to any express representation or warranty of TransDigm in the purchase agreement that was breached by these developments. In response to a post-closing lawsuit brought by TransDigm relating to a purchase price adjustment, Alcoa counterclaimed, seeking damages caused by the two allegedly concealed matters. Specifically, Alcoa claimed that TransDigm engaged in (1) “fraudulent and active concealment of material information” based on matters not expressly covered in the purchase agreement (Count I) and (2) “fraudulent or negligent misrepresentation” based on alleged “half-truths” in specific sections of the purchase agreement (Count II).
TransDigm moved to dismiss Alcoa's counterclaims. While Vice Chancellor Parsons dismissed the counterclaims in most respects, he did allow the claim charging TransDigm with fraudulent and active concealment of material information to continue.
Before addressing TransDigm's motion to dismiss, Vice Chancellor Parsons had to determine which law governed Alcoa's claims. Generally, “Delaware courts will recognize the chosen law of contracting parties if that law has a material relationship to the transaction.” The Vice Chancellor explained that the parties' choice of Delaware law in the purchase agreement normally “is sufficient to demonstrate that Delaware has a material relationship with the agreement.”
In the face of this general principle, Alcoa contended that the purchase agreement choice of law applied to “contract-based claims only,” which “is not broad enough” to govern its fraud-based counterclaims which sounded in tort. To support their competing positions, each party cited Delaware precedent which it believed supported its argument. For his part, the Vice Chancellor relied on an earlier statement by Chancellor Leo E. Strine, Jr. that “[t]o layer the tort law of one state on the contract law of another state compounds that complexity and makes the outcome of disputes less predictable … .” 2
Consistent with Chancellor Strine's philosophy, Vice Chancellor Parsons concluded that the claims raised by Alcoa--no matter how they were characterized by the parties--centered on “'rights created [by the Purchase Agreement]’ and the parties' choice of law should govern.” On this basis, the Vice Chancellor ruled that Delaware law would govern Alcoa's counterclaims.
The Vice Chancellor also noted that the manner in which the choice of law provision was drafted was not determinative. Alcoa had claimed that the purchase agreement's governing law clause was “narrowly drafted”--it provided (as is customary) that “[t]his Agreement shall be governed by the laws of the State of Delaware, its rules of conflict of laws notwithstanding” and its failure to also “state that it applied to any controversy 'arising out of or relating to’ the agreement” meant that it did not apply to the counterclaims. Vice Chancellor Parsons rejected this argument out of hand, reaffirming that the court will “apply the law the parties chose to govern contractual rights and duties 'unless the chosen state lacks a substantial relationship to the parties or transaction or applying the law of the chosen state will offend a fundamental policy of a state with material greater interest.’”Count I Fraudulent and Active Concealment
TransDigm argued that Alcoa's counterclaims alleging fraud and active concealment on the part of TransDigm were “barred” by express provisions of the purchase agreement. Specifically, in Section 5.8, Alcoa represented that it “has undertaken such investigation and has been provided with and has evaluated such documents and information as it has deemed necessary to make an informed decision” and “agrees to accept the Shares [of the Fastener Subsidiaries] without reliance upon any express or implied representations or warranties … except as expressly set forth in this Agreement.” TransDigm argued that these representations precluded Alcoa from basing claims on any state of facts outside the four corners of the purchase agreement.
Vice Chancellor Parsons ruled that Alcoa, having made the representations in Section 5.8, “could not reasonably and justifiably have relied on extra-contractual pre-closing representations” that might have been made by TransDigm or any of its representatives. On the other hand, the Vice Chancellor found that the contract language did not bar Alcoa's claims of “active concealment based on TransDigm's alleged omissions.” Unlike the situation in previous cases relied on by TransDigm, Vice Chancellor Parsons noted that Alcoa neither (i) expressly represented in the purchase agreement that “TransDigm was making no representation as to the 'accuracy and completeness' of the information … provided to Alcoa” nor (ii) disclaimed “reliance on extra-contractual omissions.”
TransDigm attempted to “make light of this distinction” between representations and omissions, arguing that the breadth of Alcoa's disclaimers in Section 5.8--particularly that Alcoa had received all documentation necessary for its evaluation of the transaction--were sufficient to bar Alcoa's claim that TransDigm had concealed material information about the key customer relationship that had soured following closing. But Vice Chancellor Parsons found the absence of disclaimers as to completeness and omissions to be fatal to TransDigm's argument, observing that “Alcoa reasonably could have relied on the assumption that TransDigm was not actively concealing information that was responsive to Alcoa's inquiries … .”Count II Fraudulent/Negligent Representation
Alcoa claimed that certain representations made by TransDigm in the purchase agreement to the effect that relationships with key customers had not been adversely affected since a specified date were actionable “half-truths.” In essence, Alcoa claimed that TransDigm had selected dates that it “knew only just avoided making the representations actually false,” thereby causing “a false impression as to the true state of affairs.”
While Delaware does in fact recognize that “a half-true statement 'may constitute an actionable misrepresentation if it causes a false impression as to the true state of affairs,” Vice Chancellor Parsons found Alcoa's reliance on this principle under the state of facts before him to be “flawed.” In the Vice Chancellor's opinion, the language of the representation was not “ambiguous,” nor was any “additional information … necessary to prevent an ambiguous statement of fact from being misleading.” To the contrary, the negotiation of the start dates for the representations was an “agreed upon allocation of risk between sophisticated parties.” The Vice Chancellor had no interest in “rewriting the parties' contract to eliminate an unambiguous term to which Alcoa now regrets that it agreed.”
There are several key takeaways from Vice Chancellor Parsons' opinion in TransDigm that should be considered by any lawyer when drafting a purchase agreement between relatively sophisticated parties:
• Generally speaking, the parties' expressed choice of law will be honored by the court and applied to the context of resolution of disputes arising from or in connection with the purchase agreement, regardless of how broad the governing law provision may be drafted. Thus, the parties must take care to be specific if different aspects of their relationship are to be governed by the laws of different jurisdictions.
• A seller seeking to protect itself from claims of “concealment” of material information must include specific language in the purchase agreement to that effect; a purchaser's disclaimer of reliance on extra-contractual representations and warranties will not be sufficient, without more, to cover material omissions if the facts support a concealment theory.
• Express limitations on representations and warranties will be given effect by the courts. For instance, if a party unambiguously agrees that certain representations and warranties will be operative only after a specified date, the courts will not lightly interfere with that choice.
1 C.A. No. 7135-VCP (Del. Ch. May 29, 2013).
2 Abry Partners V, L.P. v. F&W Acquisition LLC, 891 A.2d 1032, 1048 (Del. Ch. 2006).
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