No Sophisticated Buyer Agrees To Be Defrauded: Fraud Carve-Outs and Reliance Disclaimers in M&A Transactions

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Timothy A. Miller

By Timothy A. Miller

Timothy A. Miller founded the Silicon Valley office of Valle Makoff LLP after 14 years as a litigation partner at Skadden, Arps, Slate, Meagher & Flom LLP. Mr. Miller routinely advises buyers and sellers regarding the drafting and litigation of provisions related to post-closing disputes in M&A transactions, including contract claims for indemnification and extra-contractual claims for fraud. His practice is focused on commercial, fiduciary and securities litigation, claims of trade secret misappropriation, unfair and anti-competitive business practices and business and investment fraud. Mr. Miller is admitted to practice in California.

Buyers routinely agree to reliance disclaimers (also called anti-reliance or non-reliance provisions) in M&A agreements. At the same time, Buyers have increasingly demanded and obtained fraud carve-outs, which generally provide that various provisions of the contract apply “except in cases of fraud.” [ See Glenn D. West, That Pesky Little Thing Called Fraud: An Examination of Buyers’ Insistence Upon (and Sellers’ Too Ready Acceptance of) Undefined “Fraud Carve-Outs” in Acquisition Agreements , 69 Bus. Law. 1049, 1049-51 (2014).] But reliance disclaimers and fraud carve-outs exist in inherent tension because the disclaimer appears intended to vitiate extra-contractual fraud claims that the fraud carve-out purports to preserve. How will courts interpret these provisions when they conflict? And, in accepting a reliance disclaimer, is a buyer agreeing in advance to be defrauded notwithstanding the existence of a fraud carve-out?

Delaware and New York decisions enforcing reliance disclaimers rest on a tenuous balance between the freedom of sophisticated parties to define their rights and relationship in an acquisition agreement and the age-old policy against fraud. This article will offer proactive steps a buyer can take to tip this balance in favor of the buyer to avoid relinquishing valid extra-contractual fraud claims in an M&A agreement. I focus on Delaware and New York law because many parties choose one or the other to govern their acquisition agreements. [California law is likely less hospitable to the enforcement of non-reliance provisions to preclude fraud claims. SeeRon Greenspan Volkswagen, Inc. v. Ford Motor Land Develop. Corp., 38 Cal. Rptr. 2d 783, 787-89 (Cal. Ct. App. 1995).]

Reliance Disclaimers

In general, reliance disclaimers provide that, in entering into the transaction, the parties relied only on those representations and warranties expressly contained in the four corners of the agreement, or that seller shall have no liability resulting from the provision of information to the buyer during the due diligence process. (See, e.g., Abry Partners V, L.P. v. F&W Acquisition LLC, 891 A.2d 1032, 1041 (Del. Ch. 2006); see generally G. West & B. Lewis, Jr., Contracting To Avoid Extra-Contractual Liability—Can Your Contractual Deal Ever Really Be The “Entire” Deal? , 64 Bus. Law. 999, 1031-33, 1037-38 (2009).)

Sellers typically combine reliance disclaimers with indemnification for losses arising from breaches of representations and warranties in the agreement (or third party claims which, if true, would constitute a breach by seller). The parties often agree that indemnification under the contract, sometimes subject to a monetary cap and floor, will be the exclusive remedy for breach of the agreement. This structure in effect creates strict liability on the part of a seller in the event a representation or warranty turns out to be false, i.e. buyer need not prove intent or even negligence by seller.

We all learned in law school that fraud vitiates every contract. ( SeeAbry, 891 A.2d at 1061; see alsoDanann Realty Corp. v. Harris, 157 N.E.2d 597, 600-606 (N.Y. 1959) (Fuld, J., dissenting) (discussing cases vitiating reliance disclaimers under this common law rule in several states and the House of Lords in England).) Courts in Delaware and New York work around this venerable rule of law to enforce a reliance disclaimer and dispose of extra-contractual fraud claims on the primary theory that the disclaimer constitutes an admission and representation of a sophisticated buyer that, in entering into the transaction, it in fact did not rely on any representations not expressly stated in the agreement.


Delaware courts enforce reliance disclaimers to avoid a “double fraud”: the alleged extra-contractual fraud of the seller and the perceived fraud of the buyer in falsely representing that it did not rely on extra-contractual representations. ( Abry, 891 A.2d at 1058.) Courts rationalize this approach on the theory that a sophisticated buyer can protect itself by adjusting the acquisition price to account for the risk of extra-contractual fraud. ( See, e.g., id. at 1061.)

Under Delaware law, a general integration clause, in which the parties agree that they have made no representations or warranties not contained in the agreement, is not sufficient to preclude a common-law fraud claim. Rather, the agreement must contain a clear and affirmative disclaimer of reliance, and “the disclaimer must come from the point of view of the aggrieved party (or all the parties to the contract) to ensure the preclusion of fraud claims for extra-contractual statements.” ( FdG Logistics LLC v. A&R Logistics Holdings, Inc., 131 A.3d 842, 860 (Del. Ch. 2016).)

Accordingly, it is not enough under Delaware law for the seller to state in the agreement that it made no representations outside the four corners of the contract; the buyer must also affirmatively agree and represent that it did not rely on any representations outside the agreement, or specify precisely that upon which it did rely. ( Id.) The Delaware Court of Chancery has held that this is a “critical” distinction that “strike[s] an appropriate balance between holding sophisticated parties to the terms of their contracts and simultaneously protecting against the abuses of fraud.” ( Id. at 858.)

New York

Like Delaware, New York courts hold buyers to their reliance disclaimers based primarily on the sophistication of the parties, the sanctity of contract, and the theory that permitting a buyer to escape the disclaimer would be to sanction a double fraud. ( See, e.g., Danann Realty, 157 N.E.2d at 599-601; DynCorp v. GTE Corp., 215 F. Supp. 2d 308, 319-320 (S.D.N.Y. 2002); UniCredito Italiano SPA v. JPMorgan Chase Bank, 288 F. Supp. 2d 485, 498-99 (S.D.N.Y. 2003).) The disclaimer must be specific; a court applying New York law will determine whether the allegedly misrepresented facts come within the scope of the disclaimer. ( See Harsco Corp. v. Segui, 91 F.3d 337, 345 (2d Cir. 1996) (“where a party specifically disclaims reliance upon a particular representation in a contract, that party cannot, in a subsequent action for common law fraud, claim it was fraudulently induced to enter into the contract by the very representation it has disclaimed reliance upon”); see also DynCorp, 215 F.Supp.2d at 319.)

The distinction deemed “critical” by the Delaware courts might not be as important in New York. If the buyer agrees that seller made no representations other than those contained in the agreement, such a provision may preclude a fraud claim based on extra-contractual representations. In Harsco Corporation, the purchase agreement provided that sellers “shall not be deemed to have made to Purchaser” any extra-contractual representations or warranties, and that sellers “make no representation or warranty to Purchaser with respect to” projections, estimates or budgets and any other information provided during diligence. ( Harsco Corp., 91 F.3d at 342-43.) In affirming the dismissal of fraud claims, the Second Circuit held that buyer “should be treated as if it meant what it said when it agreed . . . that there were no representations other than those contained in” the agreement. ( Id. at 346.) Such a provision would not pass muster under Delaware law as set forth in FdG Logistics because the purchase agreement in Harsco Corporation did not contain a specific disclaimer of reliance from the point of view of the buyer.

New York courts recognize a significant “peculiar knowledge” exception to the enforcement of reliance disclaimers: “‘even where the parties have executed a specific disclaimer of reliance on a seller’s representations, a purchaser may not be precluded from claiming reliance on any oral misrepresentations if the facts allegedly misrepresented are peculiarly within the seller’s knowledge.’” ( Harbinger Capital Partners Master Fund I, Ltd. v. Wachovia Capital Markets LLC, No. 602529/08, 2010 WL 2431613, at *5 (N.Y. Sup. Ct. May 10, 2010) (unreported decision) (quoting Tahini Invs., Ltd. v. Bobrowsky, 470 N.Y.S.2d 431 (N.Y. App. Div. 1984)) (emphasis added); see also UniCredito Italiano, 288 F. Supp. 2d at 498-99; Patriot Exploration, LLC v. SandRidge Energy, Inc., 951 F. Supp. 2d 331, 353-56 (D. Conn. 2013) (applying New York law).)

“[T]he peculiar knowledge exception applies not only where the facts allegedly misrepresented literally were within the exclusive knowledge of the defendant, but also where the truth theoretically might have been discovered, though only with extraordinary effort or great difficulty.” ( DIMON Inc. v. Folium, Inc., 48 F. Supp. 2d 359, 368 (S.D.N.Y. 1999) (emphasis added).) “Factors relevant in determining whether a party may use the peculiar knowledge exception are the buyer’s (i) level of sophistication and (ii) access to the information underlying the alleged misrepresentation.” ( In re MarketXT Holdings Corp., Adversary No. 05-01082 (ALG), 2006 WL 2864963, *12 (Bankr. S.D.N.Y. Sept. 29, 2006).)

The determination as to whether the allegedly concealed facts could have been discovered by a sophisticated buyer is a fact intensive inquiry. Accordingly, the allegation that the concealed facts were within the peculiar knowledge of the seller is not easily defeated at the dismissal stage. ( See Harbinger Capital, 2010 WL 2431613, at *7 (refusing to dismiss claim that seller overstated revenues by 90% in diligence); Patriot Exploration, 951 F. Supp. 2d at 355 (denying motion to dismiss despite holding that alleged misrepresentations in estimates and projections came within scope of reliance disclaimer because seller allegedly concealed fact that it did not account for “plant shrink” in its projections, even though plant shrink had been disclosed in seller’s SEC filings); DIMON, 48 F. Supp. 2d at 369 (denying motion to dismiss despite recognizing that “it seems reasonable to assume that a sufficiently intensive review prior to the signing of the agreements would have revealed that which was discovered later”).)

The New York/Delaware Ivory Tower Legal Fiction

The holdings of these Delaware and New York courts rest on an ivory-tower legal fiction that ignores the reality of M&A transactions. A buyer cannot adjust the price based on material information that is intentionally misrepresented or concealed from it for the simple reason that one does not know what one does not know.

New York courts point to the sophistication of the buyer and the freedom of contract, holding that a sophisticated buyer should be free to disclaim reliance on the “total mix” of information. But a sophisticated buyer is, at least arguably, duty bound to consider the total mix of information. Consider, for example, a private equity professional investigating a target for one of several investment funds. One could argue that he or she owes a duty to the fund investors to consider the total mix of information provided by the seller not only in deciding whether to sign the acquisition agreement and close, but also whether and the extent to which he or she will agree to disclaim reliance and thereby limit the scope of otherwise potentially actionable representations down the road. The same could be said of the officer or director with fiduciary duties to an acquiring company’s shareholders.

Buyers rely on massive amounts of information contained in online data rooms that are not set forth or warranted by sellers in the agreement. In addition, sellers often provide historical and projected financial and other information between the signing of the contract and closing that is critical to the buyer’s decision to move forward. Buyers rely on this total mix of information in assessing the risk of agreeing, in effect, to waive future extra-contractual fraud claims in a reliance disclaimer. It is certainly within the latitude afforded fiduciaries under the business judgment rule and similar doctrines to agree in an acquisition contract to limit actionable representations in reliance on the total mix of information. But when this total mix of information is polluted with fraud, the buyer’s agreement to limit seller’s liability through a reliance disclaimer should be vitiated. ( See Danann Realty, 157 N.E.2d at 603 (Fuld, J., dissenting) (quoting a 1907 opinion of the House of Lords in England permitting fraud claims to proceed notwithstanding a reliance disclaimer: “‘When the fraud succeeds, surely those who designed the fraudulent protection cannot take advantage of it. Such a clause would be good protection against any mistake or miscalculation, but fraud vitiates every contract and every clause in it.’”) (emphasis added).)

Some commentators belittle the venerable rule that fraud vitiates everything it touches as based on misguided notions of the moral reprehensibility of fraud, urging courts to recognize legitimate reasons that sophisticated parties might agree to reliance disclaimers. ( See, e.g., Allen Blair, A Matter of Trust: Should No-Reliance Clauses Bar Claims for Fraudulent Inducement of Contract? , 92 Marq. L. Rev. 423, 429-432 (2009).) But a rule permitting sellers to contract around their fraud through reliance disclaimers undermines the sanctity and freedom of contract upon which courts rely in enforcing those provisions. ( See Abry, 891 A.2d at 1059-60 (“there is also a strong American tradition of freedom of contract, and that tradition is especially strong in [Delaware], which prides itself on having commercial laws that are efficient”).) The freedom of contract and the efficiency of commercial laws depends on the integrity and good faith of the due diligence process, which is compromised and undermined when a seller is permitted to contract away its liability for intentional fraud. ( SeeTransched Systems Ltd v. Versyss Transit Solutions LLC, C.A. No. 07C-08-286 WCC, 2008 WL 948307, at *4 (Del. Super. Ct. April 2, 2008) (“In spite of due diligence by sophisticated parties, the Court can never be in a position to condone or prevent redress for clearly fraudulent activity. The interaction between contracting parties must be done in good faith by parties whose conduct meets reasonable business and ethical standards and not one masterminded with an evil intent to fraudulently mislead the other party.”).)

Delaware law is also internally inconsistent because the “critical” distinction at the fulcrum of Delaware’s balance between fraud and freedom of contract is one without a difference. The Chancery Court acknowledged as much in FdG Logistics when it noted that “[t]he difference between a disclaimer from the point of view of a party accused of fraud and from the point of view of a counterparty who believes it has been defrauded may seem inconsequential, like two sides of the same coin.” (131 A.3d at 860.) Although it went on to deem the distinction critical, it was right the first time. If the agreement of a sophisticated buyer that it has not relied on any representations or warranties outside the contract can vitiate a fraud claim by precluding evidence of reliance on such representations, then an express agreement by that same buyer that the seller in fact made no such representations or warranties should have the same effect. How can a buyer rely on a representation that it agreed seller never made? ( SeeHarsco Corp., 91 F.3d at 346-47 (holding that disclaimer of extra-contractual representations by seller amounted to disclaimer of reliance by buyer).)

FdG Logistics highlights the tenuous basis upon which the Chancery Court’s “critical” distinction rests. The merger agreement at issue in that case not only contained a general disclaimer by the seller of extra-contractual representations, but also specifically provided that seller made no representations with respect to any projections, estimates or budgets provided in due diligence. (131 A.3d at 858.) Under the Chancery Court’s reasoning, in the absence of a disclaimer from the buyer’s point of view, the buyer would be permitted to base a fraud claim on the very same projections, estimates and budgets seller specifically disclaimed. If the buyer specifically and expressly agreed that seller made no representations regarding such forward-looking financial information, how could it justifiably rely on those representations?

Similarly, New York law is internally inconsistent because it simultaneously holds that a sophisticated party should be held to its contractual reliance disclaimers but that such disclaimers should be ignored if the fraud is sufficiently sophisticated. Under the “peculiar knowledge” exception (discussed above), New York courts will ignore the disclaimer if the fraud was so sophisticated that it could not be detected without “extraordinary effort or great difficulty.” ( DIMON, 48 F. Supp. 2d at 368; see alsoDynCorp, 215 F. Supp. 2d at 322-23 (exception applies under DIMON where “alleged fraud was hidden . . . requiring extraordinary effort and sophisticated consultants to unmask”).) All frauds are hidden; otherwise, they would not be frauds. And most frauds in complex M&A transactions are sophisticated and designed to avoid detection by buyers (and their consultants), who are well versed in the rigors of due diligence.

Nevertheless, this is the law of Delaware and New York. An affirmative disclaimer of reliance by the buyer will preclude extra-contractual fraud claims, including affirmative misrepresentations by the seller, material omissions in the diligence process (if reliance on omissions is expressly disclaimed), and under certain circumstances misrepresentations or omissions made after the execution of the agreement but before closing. ( See, e.g., Universal American Corp. v. Partners Healthcare Solutions Holdings, L.P., 176 F. Supp. 3d 387, 403 (D. Del. 2016); TransDigm Inc. v. Alcoa Global Fasteners, Inc., C.A. No. 7135–VCP, 2013 WL 2326881, at *8-9 (Del. Ch. May 29, 2013) (fraud claims allowed to proceed where buyer did not specifically disclaim reliance on omissions in diligence process); DynCorp, 215 F. Supp. 2d at 327 (granting leave to amend to plead post-contract, pre-closing fraud claims because buyer did not expressly disclaim reliance on information provided during that period in the acquisition agreement).) It will also bar fraud claims in excess of contractual limitations on remedies based on misrepresentations in the agreement absent an effective fraud carve-out. ( See, e.g., id. at 326.)

Fraud Carve-Outs

To protect against extra-contractual fraud (and fraudulent representations in the agreement that may cause losses exceeding indemnity caps), buyers increasingly insist on the inclusion of fraud carve-outs in M&A agreements. These provisions can be more or less elaborate, but generally provide that certain limitations in the agreement apply “except in cases of fraud.” So, for example:

  •  The merger or integration clause might provide that the agreement contains and supersedes all prior agreements, understandings and representations of the parties, except in cases of fraud;
  •  The exclusive remedies provisions may provide that the indemnity rights of the buyer (including caps on indemnity) shall be the sole and exclusive recourse for a breach of the agreement, except in cases of fraud; and
  •  The parties may represent and warrant in a reliance disclaimer that they have not relied on any representations or warranties not expressly stated in the agreement, except in cases of fraud.

Recent Delaware decisions evince a trend toward enforcement of these fraud carve-outs in cases of extra-contractual fraud by sellers. In Eni Holdings, LLC v. KBR Group Holdings, LLC, C.A. No. 8075-VCG, 2013 WL 6186326 (Del. Ch. Nov. 27, 2013), the Chancery Court denied a motion to dismiss a fraud claim brought outside the contractual limitation period despite the absence of a fraud carve-out in the limitations provision because the parties agreed to fraud carve-outs that applied to the exclusive remedies provisions in general. ( Id. at *15-16.) More recently, in JCM Innovation Corporation v. FL Acquisition Holdings, Inc., C.A. No. N15C-10-255 EMD CCLD, 2016 WL 5793192 (Del. Super. Ct. Sep. 30, 2016), the Delaware Superior Court allowed fraud claims to proceed based on fraud carve-outs contained in the exclusive remedies provision and reliance disclaimer, but not in the integration clause. ( Id. at *7-9.)

Which Provision Controls In Cases Of Extra-contractual Fraud?

If an acquisition agreement contains a clear, affirmative and therefore enforceable disclaimer of reliance by the buyer and a fraud carve-out, which provision will control in the case of extra-contractual fraud?

Delaware: Fraud Carve-Out May Tip The Balance

The Chancery Court’s holdings in JCM Innovation and Eni Holdings suggest that strong fraud carve-outs will control over contractual limitations on a buyer’s remedies. In JCM Innovation, a company engaged in the sale of printers and currency validators to slot machine manufacturers purchased FutureLogic from a private equity firm. (2016 WL 5793192, at *1.) The buyer expressly disclaimed reliance on certain “Projections” provided by seller (subject to a fraud carve-out) and disclaimed that the seller had made any representations or warranties outside the four corners of the agreement. ( Id. at *6, *8.) The exclusive remedies provision contained extensive fraud carve-outs, but the parties did not include fraud carve-outs in the provision limiting seller’s representations and warranties to those stated in the agreement or the integration clause. ( Id. at *6, 8.)

In diligence, the seller allegedly touted its casino gaming printers as “fast, robust, next generation technology.” ( Id. at *2.) When third parties brought claims for malfunction of the printers after closing, Buyer alleged in extra-contractual fraudulent inducement claims that seller intentionally withheld knowledge of significant quality issues and poor performance of the printers, and understated estimates of future warranty costs associated with the printers. ( Id. at *2-3.) Noting that “Delaware has a strong public policy distaste for fraud” ( id. at *7), the court allowed the fraudulent inducement claims to proceed based in part on the allegedly fraudulent estimates of future warranty costs even though the buyer had expressly disclaimed reliance on “projections, estimates and other forecasts” provided by seller. ( Id. at *8.) The court highlighted language in the reliance disclaimer that carved out “any rights that Purchaser has with respect to . . . any intentional misconduct by Seller.” ( Id. at *8.) The court also highlighted four fraud carve-outs contained in the exclusive remedies provision alone, holding: “The Exclusive Remedy Provision explicitly sets forth JCM’s options for claims under the Agreement. JCM can go through the indemnification process, or it can bring fraud claims.” ( Id. at *7.) The court dismissed breach of contract claims in excess of contractual caps based on the exclusive remedies provision. ( Id. at *9.)

JCM Innovation thus suggests that fraud carve-outs in the exclusive remedies provision and reliance disclaimer will preserve extra-contractual fraud claims even where buyer expressly and specifically disclaims reliance on the particular allegedly fraudulent information. Eni Holdings suggests that the fraud carve-out will control even where it is not contained in the specific provision at issue. In that case, as discussed above, the Chancery Court refused to preclude a fraud claim brought outside a contractual limitation on the time within which a claim could be brought based on the existence of fraud carve-outs contained in other provisions of the agreement. A buyer might argue by extension that a fraud carve-out should control over a reliance disclaimer, which is in effect a contractual limitation of buyer’s remedies.

A seller may argue that because a reliance disclaimer constitutes, as a matter of law, a factual admission by the buyer that it did not rely on the alleged extra-contractual misrepresentation, no fraud claim exists to be “carved out.” The seller may attempt to reconcile the reliance disclaimer and fraud carve-out by arguing that the intent of the parties was not to permit extra-contractual fraud claims, but instead to permit claims in excess of contractual limits on recovery in the case of fraud with respect to misrepresentations contained in the agreement. ( See Abry, 891 A.2d at 1062-64.)

A buyer could counter that the presence of a fraud carve-out in an acquisition agreement tips the balance back in favor of the “venerable public policy to guard against fraud.” ( FdG Logistics LLC, 131 A.3d at 859.) The Chancery Court in FdG Logistics reasoned that the Abry court struck “an appropriate balance” between enforcement of agreements between sophisticated parties and protecting against fraud. ( Id. at 858.) It also held, as noted above, that the balance tips back to the allegedly defrauded buyer if the agreement does not contain a clear and affirmative disclaimer of reliance from the point of view of the buyer. One could argue that where the parties, in effect, agree in a fraud carve-out that all bets are off in the case of fraud, then this delicate balance tips back toward the strong public policy against fraud even if the buyer expressly and affirmatively disclaimed reliance in the fraudulently induced agreement.

Such an approach would be consistent with Delaware case law allowing claims for fraudulent inducement of a settlement agreement and release. In E.I. DuPont de Nemours & Co. v. Florida Evergreen Foliage, 744 A.2d 457 (Del. 1999), the Delaware Supreme Court held that a plaintiff that settled a prior products liability litigation could bring a claim for fraudulent inducement of the settlement agreement based on alleged fraud in the litigation discovery process despite agreeing to a broad release of claims, whether known or unknown. ( Id. at 461-62.) A buyer in an M&A transaction could argue that fraud in the litigation discovery process is like fraud in the diligence process; in both, one party requests information to value an asset (in the DuPont case, the value of a claim, and in an acquisition the value of the company to be acquired). Thus, just as discovery fraud taints the litigation process and precludes a plaintiff from properly valuing its litigation claim, fraud in diligence taints the acquisition process and prevents a buyer from properly determining the price to be paid.

New York: Fraud Carve-Out May Restore Buyer’s Reliance on Total Mix of Information

This author has found no decisions under New York law addressing a conflict between a reliance disclaimer and a fraud carve-out in an M&A agreement. However, one could argue that a fraud carve-out should control over a reliance disclaimer to permit extra-contractual fraud claims under the same logic employed by New York courts to enforce the disclaimers. New York courts emphasize the power of sophisticated parties to agree as part of the contractual allocation of risks that any future claim for breach of contract or fraud shall be limited to the representations in the contract, in effect contracting away actual reliance on the “total mix” of material information. New York will enforce such reliance disclaimers even where the buyer in fact may have relied on that total mix. ( See DynCorp, 215 F. Supp. 2d at 311 (interpreting reliance disclaimer as representation by buyer that it relied solely on representations of seller in the agreement and “not on the mix of data and information supplied to it” by seller).)

If the parties to an M&A transaction can agree to such a legal fiction through a reliance disclaimer, they should also be able to carve fraud out of that reliance disclaimer, i.e., to restore buyer’s ability to claim reliance on the total mix of information in cases of fraud. The provisions may be reconciled by finding that the intent of the reliance disclaimer is to exclude breach of contract, breach of warranty and negligent misrepresentation claims based on extra-contractual representations, but the inclusion of a fraud carve-out evidences the intent of the parties not to preclude extra-contractual fraud claims.

How Can Buyers Proactively Guard Against Extra-contractual Fraud?
Just Say No to Reliance Disclaimers

The legal fiction adhered to by Delaware and New York courts in the enforcement of reliance disclaimers places buyers in a difficult position. If a buyer agrees to include such a disclaimer in an M&A agreement, it runs the risk that extra-contractual fraud claims will be barred even if buyer obtains a fraud carve-out. The Chancery Court laid down the challenge to buyers in espousing its “double fraud” theory: “The enforcement of non-reliance clauses recognizes that parties with free will should say no rather than lie in a contract.” ( Abry, 891 A.2d at 1058.)

Buyers should resist the inclusion of broad reliance disclaimers because the justifications for those provisions do not hold water. A seller is adequately protected by the common law of fraud, which generally requires an allegedly defrauded buyer to plead and prove that seller had a duty to speak on the allegedly misrepresented topic, knowingly or recklessly misrepresented or omitted material facts to induce buyer to enter into the transaction, and that buyer actually and justifiably relied on those misrepresentations or omissions in closing the deal. An honest seller should need no more. ( See Danann Realty Corp., 157 N.E.2d at 606 (Fuld, J., dissenting) (the rule that fraud vitiates every contract, including a reliance disclaimer, “presents no obstacle to honest business dealings, and dishonest transactions ought not to receive judicial protection”).)

Courts routinely point to the sophistication of the parties engaged in M&A transactions, holding that a sophisticated buyer can protect itself with more diligence and has the ability to adjust the purchase price to account for any uncertainties. ( See Abry, 891 A.2d at 1058.) Citing “the need for commerce to proceed in a rational and certain way,” then-Vice Chancellor Leo Strine noted that the Chancery Court “respect[s] the ability of sophisticated businesses . . . to make their own judgments about the risk they should bear and the due diligence they undertake, recognizing that such parties are able to price factors such as limits on liability.” ( Id. at 1061.) But, as discussed above, a buyer cannot price fraud into the deal because, by definition, the buyer does not know that it has been defrauded and has no knowledge of the facts that seller has misrepresented or omitted.

The Chancery Court in Abry suggested that even absent exposure to fraud claims, a sophisticated seller would be reticent to dupe its sophisticated business adversary for fear it “gets a rap as a fraudster.” ( Abry, 891 A.2d at 1061.) In reality, the absence of a legal remedy for fraud often has the opposite effect. The Abry court posited that a sophisticated private equity seller will be sensitive to “reputational factors” before defrauding another private equity buyer, and that “[h]aving a bad reputation is likely to be costly.” ( Id.) But no private equity buyer wants a reputation as a crybaby who claims fraud when its diligence falls short and it strikes a bad deal. The fear of such a perception, right or wrong, can shut the mouth of the fraud victim absent a judicial means to vindicate his claims of fraud. No words in a contract should remove that right. As the dissent in Danann Realty observed, quoting Judge Augustus Hand: “’the ingenuity of draftsmen is sure to keep pace with the demands of wrongdoers, and if a deliberate fraud may be shielded by a clause in a contract that the writing contains every representation made by way of inducement, or that utterances shown to be untrue were not an inducement to the agreement,’ a fraudulent seller would have a simple method of obtaining immunity for his misconduct.” ( Danann Realty, 157 N.E.2d at 606-607 (Fuld, J., dissenting) (citation omitted).)

One commentator argued that reliance disclaimers are justified to reduce the agency costs of the seller. The commentator reasons that it is expensive for a seller to monitor what each of its agents may represent to a buyer in a complex merger transaction. (A. Blair, supra, 92 Marq. L. Rev. at 472-73.) This argument flies in the face of agency law, which generally holds a principal responsible for the fraud of its agent perpetrated in the ordinary course of the agency and for the benefit of the principal. Indeed, a corporation can act only through those it duly authorizes as its agents and representatives. The law places the responsibility on the seller for fraud committed by its agents, and by logical extension to monitor the representations made by those agents to avoid fraud on the buyer.

Courts and commentators also point to the desire of sellers to avoid the cost and distraction of litigating unfounded fraud claims. ( See Abry, 891 A.2d at 1058 (noting the “reality . . . that courts are not perfect in distinguishing meritorious from non-meritorious claims of fraud” and finding that enforcement of reliance disclaimers “minimizes the risk of erroneous litigation outcomes by reducing doubts about what was promised and said”).) This reasoning assumes, of course, that the future fraud claim is non-meritorious. A reliance disclaimer precludes all fraud claims, not just unfounded fraud claims. Moreover, as discussed below, other steps can be taken to mitigate the potential cost of non-meritorious fraud claims.

In the final analysis, a reliance disclaimer is tantamount to an agreement in advance to absolve the seller for fraud in the diligence process. No rational buyer, sophisticated or otherwise, would agree in advance to be defrauded.

If Seller Insists, Limit the Reliance Disclaimer.

A buyer faced with the inclusion of a reliance disclaimer may want to consider some of the following methods for limiting its impact.

Limit Disclaimer to Specific Representations or Information Not Relied Upon

Delaware and New York courts value specificity in the enforcement of reliance disclaimers, and punish buyers who agree to broad promises that they did not rely on any extra-contractual representations. This result can be avoided if the reliance disclaimer specifies those representations made or items of information provided in the course of diligence upon which the buyer has not relied, while at the same time avoiding a sweeping catch-all reliance disclaimer.

Limit Disclaimer to Known Unknowns

As the Chancery Court held in another context, “where the inherent unknowability of a potential claim is itself knowable or predictable,” it is “the proper source of negotiation and resolution between the parties to the contract.” ( Eni Holdings, LLC, 2013 WL 6186326, at *14 (holding that the discovery rule did not apply to toll a contractual limitations period).) Similarly, many representations made by a seller during diligence are forward looking, and thus the accuracy of those representations is inherently unknowable. The parties can allocate the risk of this inherent unknowability by limiting the reliance disclaimer to specific categories of such forward looking statements, such as projections, budgets or estimates, to the extent the forward looking statements are not fraudulent and therefore subject to the fraud carve-out. ( See Universal American Corp., 176 F. Supp. 3d at 395-96 (finding strong inference of scienter under PSLRA where seller was allegedly aware of at least five MAEs that would be expected to reduce forecasts provided by seller in due diligence, and true sales pipeline concealed by seller).)

Seller may contend that such an approach would permit fraud claims based on information requested in diligence even where seller denies the requests without suggesting that the requested information does not exist. But such information is not inherently unknowable; buyer knows it has been denied material information in diligence and nevertheless decides to proceed at its own peril. ( See DynCorp, 215 F. Supp. 2d at 322 (“Sophisticated parties to major transactions cannot avoid their disclaimers by complaining that they received less than all information, for they could have negotiated for fuller information or more complete warranties.”); Harsco Corp., 91 F.3d at 347 (“it cannot be said that denial of a request to see documents could constitute fraud, unless that denial suggested falsely and deceitfully that those documents did not exist”); Lazard Freres & Co. v. Protective Life Ins. Co., 108 F.3d 1531 (2d Cir. 1997) (failure of buyer to obtain report on acquired debt despite knowing of its existence barred fraud claims); Rodas v. Manitaras, 552 N.Y.S.2d 618, 620 (N.Y. App. Div. 1990) (where seller refused buyers’ request to examine business records, “plaintiffs clearly assumed the risk that the documentation might not support the $20,000 weekly income that was represented to them”.)

Request a Strong, Broad Fraud Carve-Out

Ask for a broad, centralized fraud carve-out that makes clear all bets are off in the case of fraud. Such a provision may read: “Notwithstanding any provision in this Agreement including but not limited to [cross reference reliance disclaimer, exclusive remedies provisions, indemnification provisions and merger clause], each party expressly reserves and does not intend to waive any rights, remedies or claims based on fraud or intentional wrongdoing of the other party. Seller acknowledges that it and its representatives have provided Buyer with certain information prior to the execution of this Agreement and will provide additional information prior to the Closing. The disclaimers of Buyer contained in [cross reference the reliance disclaimer] apply solely to limit the representations and warranties that may form the basis of a claim for breach of this Agreement or indemnity under [cross-reference indemnity and exclusive remedy provisions], and are not intended and shall not be construed to preclude a claim by Buyer based on the intentional fraud or wrongdoing of the Seller or its representatives.”

Alternatively, Sprinkle Fraud Carve-Outs Liberally Throughout Agreement

If the dynamics of the transaction limit buyer to including the phrase “except in cases of fraud” in one or more provisions of the agreement, press to include it in as many provisions as possible. Critical provisions that should be subject to a fraud carve-out are the reliance disclaimer, the exclusive remedies provisions, the indemnification provisions and the integration clause. Sellers may agree to include the carve-out in all but the reliance disclaimer, arguing that to carve fraud out of the disclaimer is to eviscerate it. Not so. The inclusion of a fraud carve-out in the disclaimer makes clear that the disclaimer is limited to honest mistake or negligent misrepresentation. It also avoids the argument that the omission of a fraud carve-out in the reliance disclaimer was intentional because the parties included it elsewhere and, therefore, certainly could have included it in the disclaimer if they intended to permit extra-contractual fraud claims.

If Seller Complains About Litigation Risk, Agree to Procedural Safeguards and Limited Threshold ADR

Courts and commentators point to a seller’s legitimate desire to avoid the burden and expense of meritless future fraud claims as a justification for the inclusion of reliance disclaimers. However, the understandable desire of a seller to limit its exposure to the inefficiencies inherent in our justice system stands in tension with the general abhorrence for fraud. Quoting a 1927 decision of the Supreme Court of Minnesota, the dissent in Danann Realty noted:

And, said the court, while the argument that a party should have the right “to let his work to a certain person because the other will therein agree that he relies and acts only upon his own knowledge and not upon the representations of his adversary”, might on first thought seem plausible, it does not stand analysis. “It may be desirable in dealing with unscrupulous persons to have this clause as a shield against wrongful charges of fraud. But if there is no fraud that fact will be established on the trial. The merits of defendant’s claim reach only the expense and annoyance of litigation. But every party should have his day in court. . . .”
( Danann Realty, 157 N.E.2d at 604 (Fuld, J., dissenting) (quoting Ganley Bros. v. Butler Bros. Bldg. Co., 212 N.W. 602, 603 (Minn. 1927)) (emphasis added).)

One possible alternative approach to address this concern would be to incorporate procedural protections against baseless extra-contractual fraud claims into the acquisition agreement. For example, the fraud carve-out could include an agreement to submit any potential fraud claims (extra-contractual or otherwise) to limited mandatory arbitration. The parties could agree to select an arbitrator (or panel of arbitrators) experienced in the resolution of fraud claims at the pleading stage, and require the arbitrator(s) to determine whether the fraud claims satisfy the heightened pleading requirements of the PSLRA as that statute has been interpreted in the federal courts (or the parties could specify a particular jurisdiction, such as the Second or Ninth Circuit).

The parties could further agree that no discovery and no court action would be permitted on any such fraud claim unless and until it survives the ADR pleading stage. The parties could also include an attorneys’ fees provision, providing for an award of fees and costs to the seller in the event of a failure of a fraud claim to survive the pleading stage in ADR. Finally, the seller could agree that if the pleading survives the ADR pleading stage, the seller will not challenge the pleading once filed in court, but instead will answer the complaint and proceed to discovery under the applicable court procedures.

Such an approach should be enforceable under laws favoring alternative dispute resolution. Moreover, it should be valid notwithstanding case law prohibiting a party from absolving itself in advance for its fraud because the approach does not eliminate the possibility of a fraud claim; it merely subjects any fraud claim to preliminary threshold alternative dispute resolution.


No sophisticated buyer would agree to be defrauded. Reliance disclaimers unchecked by strong fraud carve-outs can leave a buyer with no recourse should it learn post-closing that information provided by seller in due diligence—information that buyer in the discharge of its fiduciary and other duties must consider as part of the total mix of information—was fraudulent. If a seller insists on reliance disclaimers, care should be taken to preserve legitimate fraud claims through the liberal inclusion of clear and unambiguous fraud carve-outs.

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