Tort Law's Continued Intrusion Into the M&A Agreement ... Law's Continued... · on an owner of an...

Weil, Gotshal & Manges LLP

Tort Law's Continued Intrusion Into

the M&A Agreement —

What to Do About It, If Anything

Dallas Bar Association – M&A Section Meeting

Glenn D. West

David B. Gail

April 14, 2015© Glenn D. West

Weil, Gotshal & Manges LLP 2

What is the key problem we’re trying to address?

� Buyers dissatisfied with their purchase often attempt to circumvent the negotiated contract by alleging tort-based fraud and negligent misrepresentation claims.

� Fraud is not limited to deliberate lies

� Veil piercing: Not a claim at all, but an equitable remedy imposing liability

on an owner of an entity otherwise liable for the contractual or tort-based

claim.

� Equitable fraud: claims premised on the simple fact that a representation

proved to be false whether or not it was known to be false when made.

� These claims are easy to allege, difficult to disprove without expensive and lengthy litigation, and highly susceptible to the erroneous conclusions of judges and juries.


How do we fix the problem?

� By carefully drafting the “boilerplate” provisions, Sellers can limit the risk of tort intrusion into their contracts.

� Agreements typically include “boilerplate” provisions intended to limit liability to (1) the parties signatory to the agreement, (2) the matters specifically set forth in the agreement and (3) the remedies expressly bargained for in the agreement.


Overview of Topics

� Defining an Entity-Specific Contract

� Extra-Contractual Claims and Threats to Entity-Specific Contracts

� Key Provisions to Reduce Risk of Extra-Contractual Claims

� Entire Agreement

� Non-Reliance on Extra-Contractual Representations

� Nature of Representations and Warranties

� Exclusive Remedy (and the fraud carve-out)

� Non-Recourse

� Other Traps for the Unwary

� Governing Law


What is an Entity-Specific Contract?

“Entity-Specific Contract” means:

� One or more parties is a limited liability entity, such as a corporation, limited partnership or LLC.

� The named party may be owned by a corporate parent or one or more individuals.

� Intention is that the liability under the contract will be limited to the assets of the named entity party.


Extra-Contractual Claims and Threats to Entity-Specific Contracts

Threats to entity-specific contracts include:

� Claims against entities or individuals not party to the contract

� Claims for damages beyond the scope of specific limitations set forth in the contract

� Claims based on tort theories that allow recovery of damages in excess of normal contract damages (e.g., punitive or exemplary damages)



The basis for these extra-contractual claims can consist of either:

� Equitable Theories – Collectively known as “piercing the veil”

� Tort Theories – Based on tortious acts by individuals or entities related to the negotiation or performance of the contract

� Examples include common law fraud (including fraud in the inducement), equitable fraud and negligent misrepresentation



Equitable Theories – “Piercing the Veil” Q&A

� True or False: Most successful piercing cases involving a parent-

subsidiary relationship are brought by individual plaintiffs.

� What percentage of piercing cases of all types have been successful at

the appellate court level across the United States according to a recent

survey? (a) 15%, (b) 20%, (c) 30%, or (d) 50%

� True or False: A piercing claim is much more likely to be successful in a

case involving a tort claim than in a case based solely upon a

contractual relationship?


� Tort Theories that can “contort” your contractual relationship:

1. Officers and other corporate representatives can have direct personal

liability

2. The term “fraud” encompasses more than intentional lies

3. Negligent misrepresentation is a broad catch-all tort category

Extra-Contractual Claims and Threats to Entity-Specific Contracts (cont.)


� Tort Q&A:

� Assuming you can otherwise establish a material representation was made to

you that was false when made and upon which you justifiably relied to your

detriment, which of the following mental states are required in the person

making the representation to constitute fraud?

� the person who made the representation knew it was false when he made it.

� the person who made the representation suspected it may be false when he made it.

� the person who made the statement had no idea whether the statement was true or false when he made it.

� the person believed the statement to be true, but he had only limited informationupon which to base his belief.

� the person believed the statement to be true and had substantial informationupon which to base his belief.



� “Fraud is a many splendored thing.”

� Common Law Fraud

� Equitable Fraud

� Promissory Fraud

� Unfair Dealings Fraud

� Question: When a contract carves-out “claims based on fraud” from the

exclusive remedy provision, which of the above is carved out?

Many Meanings of the Word “Fraud”


Good news - while tort principles are imposed by law, not contractually

consented to, they can be disclaimed by contract between

sophisticated parties in most states.



The Lesson of ABRY Partners v. F&W Acquisition LLC

� If you “lie” about matters covered by contractual representations, you

open the door to fraud claims and you lose the benefit of any limitations on the

remedy or cap on the damages.

� Practical considerations:

� Maintain your distance from discussions regarding unfamiliar matters; and

� Recognize the distinctness and limits of your knowledge compared to the company’s or business’s management.

� Parties can contractually exclude liability for most tort claims.

� However, under Delaware law, parties cannot contract away fraud in a contractual representation or warranty.


Further Thoughts on ABRY – What if there was an exception for fraud?

� What if the Seller in ABRY agreed to include an exception for fraud and/or

“willful breach”?

� Seller’s failure to disclose that a representation is no longer true as of

closing would entitle Buyer to exercise legal and equitable remedies outside

of the exclusive remedy, (e.g., indemnity thresholds and caps may be

inapplicable).

� DRAFTING TIP: Be aware that carve-outs for fraud, willful misconduct and

intentional misrepresentation can eviscerate an exclusive remedy provision.


Fraud Claims & New York Contract Law

� New York law recognizes three categories of fraud claims that may arise out of contractual relationship:

� (1) where a party demonstrates that its adversary had a legal duty that was separate from its duty to perform under the contract, and the alleged fraud was a breach of that separate legal duty;

� (2) where a party demonstrates a fraudulent misrepresentation “collateral or extraneous to the contract” (Bridgestone/Firestone, Inc. Recovery Credit Servs., Inc., 98 F.3d 13, 20 (2d Cir 1996); and

� (3) where a party shows “special damages that are caused by a misrepresentation and are unrecoverable as contract damages.


Fraud Claims & New York Contract Law

� However, New York courts’ interpretation of what is “collateral or extraneous to

the contract” has been confusing at best.

� Some cases state that “a plaintiff must allege a representation that is collateral to the contract, not simply a breach of a contractual warranty, and damages that are not recoverable in an action for breach of contract.”

� While others state that “a fraud claim can be based on a breach of contractual warranties notwithstanding the existence of a breach of contract claim.”


Contract Provisions to Reduce Risk of Extra-Contractual Claims

� Entire Agreement

� Non-Reliance on Extra-Contractual Representations

� Nature of Representations and Warranties

� Exclusive Remedy and Fraud Carveouts

� Non-Recourse


Entire Agreement

� Purpose:

� Defines the scope of the agreement and expressly disclaims contract terms outside the specified documents (e.g., oral representations or items contained in diligence or other documents). It is NOT a non-reliance provision.

� Triggers the parol evidence rule, limiting the evidence parties can introduce regarding their intent outside of the agreement (but generally ineffective to exclude parolevidence to show fraud in inducing the contract).

� Items to Consider:

� As a technical matter, be sure to list all related agreements that will remain in force for the pre-closing period and/or post-closing (confidentiality agreement, standstill, ancillary agreements).

� Disclaim specific extra-contractual representations if and to the extent you can foresee that the counterparty may allege reliance on them after the acquisition.

� Although the Entire Agreement provision seems to preclude the buyer from relying on extra-contractual representations, courts generally are reluctant to read the provision in this manner without a separate Non-Reliance provision.


Entire Agreement – Model Provision

� This Agreement and [list related agreements] (and all exhibits and schedules hereto and thereto) contain the entire agreement and understanding between the parties hereto with respect to the subject matter hereof and supersede all prior agreements and understandings (including any offer letters or term sheets), whether written or oral, relating to such subject matter.

� The parties hereto have voluntarily agreed to define their rights, liabilities and obligations respecting the transactions contemplated by this Agreement exclusively in contract pursuant to the express terms and conditions of this Agreement, and the parties hereto expressly disclaim that they are owed any duties or entitled to any remedies not expressly set forth in this Agreement.

� Furthermore, the parties each hereby acknowledge that this Agreement embodies the justifiable expectations of sophisticated parties derived from arm’s-length negotiations, and all parties to this Agreement specifically acknowledge that no party has any special relationship with another party that would justify any expectation beyond that of an ordinary purchaser and an ordinary seller in an arm’s-length transaction.


Entire Agreement – Model Provision (cont.)

� The sole and exclusive remedies for any breach of the terms and provisions of this Agreement (including any representations and warranties set forth herein, made in connection herewith or as an inducement to enter into this Agreement) or any claim or cause of action otherwise arising out of or related to the sale and purchase of the Company shall be those remedies available at law or in equity for breach of contract only (as such contractual remedies have been further limited or excluded pursuant to the express terms of this Agreement).

� The parties hereby agree that neither party hereto shall have any remedies or cause of action (whether in contract or in tort) for any statements, communications, disclosures, failures to disclose, representations or warranties not set forth in this Agreement.


Non-Reliance

Purpose:

Fraud claims and negligent misrepresentation claims generally require proof that a claimant reasonably

or justifiably relied on the defendant’s false statement.

Non-reliance provisions require the Buyer to state that it did not rely on any extra contractual

representations made by the Seller, providing proof of the absence of reliance necessary to support a

fraud or negligent misrepresentation claim.

The non-reliance provision is specifically intended by sellers to limit fraud liability.

Items to Consider:

When representing Sellers, remember:

A typical “entire agreement” provision is not sufficient to disclaim Buyer’s reliance on extra-

contractual reps

The agreement must include a provision by Buyer disclaiming reliance on extra-contractual reps

(and the absence of a disclosure of any specific fact) and must be specific.

When representing Buyers:

Ensure that all info and oral assertions on which Buyer is relying are covered by express

representations in the Agreement.


More on Non-RelianceHow State Law Interpretation Differs:

� In Texas, Delaware, New York, Rhode Island and many other states, the non-reliance provision is effective to waive or preclude a fraudulent inducement claim based on prior or extra-contractual representations (oral or written). See Italian Cowboy Partners. See also McLernonv. Dynegy, Inc., 347 S.W.3d 315 (Tex. App.—Houston (14th Dist.) 2011).

� Note, however, in New York, to be effective, the non-reliance provision must specifically refer to the types of representations that the counterparty could allege were made outside of the agreement and relied on by the counterparty (which may include informational categories (e.g., financials) or means of access (e.g., data rooms, management presentations, responses to questions submitted by buyer)). See Caiolo v. Citibank, NA., 295 F.3d 312, 317–18 (2d Cir. 2002).

� In Florida, California, South Carolina, Alabama, Kansas, Missouri, Nevada, New Hampshire, Oregon and Wisconsin, courts disfavor the enforcement of contractual limitations on liability, in particular a general non-reliance provision, as they relate to extra-contractual fraud:

� In Florida, in order to effectively waive or preclude a fraudulent inducement claim, the agreement must also expressly state that the parties waive their right to make a fraud claim or otherwise seek a remedy for being fraudulently induced to enter into the agreement. See Lower Fees, Inc. v. Bankrate, Inc., 74 So. 3d 517 (Fla. App. 2011).

� In Mass. and Wyoming, courts fall somewhere in the middle—allowing intentional fraud claims but enforcing non-reliance provisions against negligent misrepresentation claims.


Non-Reliance – Model Provisions

Except for the specific representations and warranties expressly made by the Company or any

Selling Stockholder in Article [_] of this Agreement:

(1) Buyer acknowledges and agrees that

(A) neither the Company nor any Selling Stockholder is making or has made any

representation or warranty, expressed or implied, at law or in equity, in respect of the

Business, the Company, the Company’s Subsidiaries, or any of the Company’s or its Subsidiaries’

respective businesses, assets, liabilities, operations, prospects, or conditions (financial or

otherwise), including with respect to merchantability or fitness for any particular purpose of any

assets, the nature or extent of any liabilities, the prospects of the Business, the effectiveness or the

success of any operations, or the accuracy or completeness of any confidential information

memoranda, documents, projections, material or other information (financial or otherwise)

regarding the Company or any Company Subsidiary furnished to Buyer or its representatives or

made available to Buyer and its representatives in any “data rooms,” “virtual data rooms,”

management presentations or in any other form in expectation of, or in connection with, the

transactions contemplated hereby, or in respect of any other matter or thing whatsoever, and

(B) no officer, agent, representative or employee of the Selling Stockholder, the Company or

any of the Company’s Subsidiaries has any authority, express or implied, to make any

representations, warranties or agreements not specifically set forth in this Agreement and

subject to the limited remedies herein provided;


Non-Reliance – Model Provisions (cont.)

(2) Buyer specifically disclaims that it is relying upon or has relied upon any such other

representations or warranties that may have been made by any Person, and acknowledges and

agrees that the Company and the Selling Shareholders have specifically disclaimed and do hereby

specifically disclaim any such other representation or warranty made by any Person;

(3) Buyer specifically disclaims any obligation or duty by the Seller, the Company or any Selling

Stockholder to make any disclosures of fact not required to be disclosed pursuant to the specific

representations and warranties set forth in Article [_] of this Agreement; and

(4) Buyer is acquiring the Company subject only to the specific representations and warranties set forth

in Article [_] of this Agreement as further limited by the specifically bargained-for exclusive remedies

as set forth in Article [_].


Nature of Representations and Warranties – Model Provisions

� All representations and warranties set forth in this Agreement are

contractual in nature only and subject to the sole and exclusive

remedies set forth herein.

� No Person is asserting the truth of any representation and warranty

set forth in this Agreement; rather the parties have agreed that should

any representations and warranties of any party prove untrue, the other

party shall have the specific rights and remedies herein specified as

the exclusive remedy therefor, but that no other rights, remedies or

causes of action (whether in law or in equity or whether in contract or in

tort) are permitted to any party hereto as a result of the untruth of any

such representation and warranty.


Exclusive Remedy

� Purpose

Limits ability of a contract party to bring an extra-contractual claim based in tort law or pursue other

equitable remedies.

Ensures that specifically bargained-for indemnification based on express representations and

warranties and other express contractual remedies is the sole recourse for transaction-related

losses.

� Items to Consider

Buyers commonly seek carve-outs for fraud, willful misconduct and intentional misrepresentation,

which have the effect of eviscerating an exclusive remedy provision.


Exclusive Remedy – Model Provisions

Basic Provision:

� Following the Closing, the sole and exclusive remedy for any and all claims arising under, out of, or related to this Agreement, or the sale and purchase of the Company, shall be the rights of indemnification set forth in Article [_] only, and no person will have any other entitlement, remedy or recourse, whether in contract, tort or otherwise, it being agreed that all of such other remedies, entitlements and recourse are expressly waived and released by the parties hereto to the fullest extent permitted by law.

� The provisions of this Section [_], together with the provisions of Sections [_], [_], and [_], and the limited remedies provided in Article [_], were specifically bargained-for between Buyer, the Company and the Selling Stockholders and were taken into account by Buyer, the Company and the Selling Stockholders in arriving at the Purchase Price. The Company and the Selling Stockholders have specifically relied upon the provisions of this Section [_], together with the provisions of Sections [_], [_], and [_], and the limited remedies provided in Article [_], in agreeing to the Purchase Price and in agreeing to provide the specific representations and warranties set forth herein.


Exclusive Remedy – Fraud Carve-outPurpose:

� Buyers commonly request (and according to market studies, receive) an

exception to the exclusive remedy provision for fraud because “no

reasonable Seller can argue that it should be protected for ‘lies’.”

Considerations:

� Seller should (if possible) reject the fraud carve-out and direct Buyer to

seek recourse through the negotiated indemnity provisions.

� If Seller agrees to include the fraud carve-out, narrowly define what

fraud is (in particular, re: scienter and re: reps in the agreement) and

what happens in the event fraud is determined to have occurred:


Examples of Negotiated Fraud Carve-outs

[N]othing herein shall operate to limit the common law liability of any Seller to Purchasers for fraud in the event such Seller is finally determined by a court of competent jurisdiction to have willfully and knowingly committed fraud against any Purchaser, with the specific intent to deceive and mislead any Purchaser, regarding the representations and warranties made herein or in any schedule, exhibit or certificate delivered pursuant hereto.

Asset Purchase Agreement, dated Jan. 23, 2014, by and among Florida Rock Industries, Inc., Florida Cement, Inc., Argos Cement LLC, Argos Ready Mix LLC, and, solely for purposes of Section 12.18, Vulcan Materials Company and Cementos Argos S.A., § 8.6, at 55, http://us.practicallaw.com/7-555-7066.

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Examples of Negotiated Fraud Carve-outs(cont.)And, an actual defined term for Fraud that is then used in the fraud carve-out to the exclusive remedy provision:

“Fraud” means, with respect to a Party, an actual and intentional fraud with respect to the making of the representations and warranties pursuant to Article IV or Article V (as applicable), provided, that such actual and intentional fraud of such Party shall only be deemed to exist if any of the individuals included on Section 1.1(vv) of the Seller Disclosure Letter (in the case of the Seller) or Buyer Disclosure Letter (in the case of the Buyer) had actual knowledge (as opposed to imputed or constructive knowledge) that the representations and warranties made by such Party pursuant to, in the case of the Seller, Article IV as qualified by the Seller Disclosure Letter, or, in the case of the Buyer, Article V as qualified by the Buyer Disclosure Letter, were actually breached when made, with the express intention that the other Party rely thereon to its detriment.

Stock Purchase Agreement, dated December 10, 2013, by and between LBD Acquisition Company, LLC (“Buyer”), and Fifth & Pacific Companies, Inc. (“Seller”), regarding the purchase and sale of the capital stock of Lucky Brand Dungarees, Inc., §1.1(ll), at 5, http://us.practicallaw.com/4-552-0885.

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Examples of Negotiated Fraud Carve-outs(cont.)An example of a clause clarifying that the fraud carve-out only applies to the selling stockholder committing the fraud (not all stockholders);

For purposes of clarity, the commission of actual fraud by a Shareholder shall not affect the application of the limitations set forth in this Article VII to any other Shareholder that has not also committed actual fraud with respect to the claim in question . . . .

Agreement and Plan of Merger, dated February 12, 2014, by and among Victory Electronic Cigarettes Corporation, VCIG LLC, FIN Electronic Cigarette Corporation, Inc., and Elliot B. Maisel, as Representative, § 7.1(d)(iv), at 31, http://us.practicallaw.com/1-558-8985.

And, an example limiting the fraud carve-out to “intentional fraud with respect to any representation and warranty of the Company set forth in Article IV,” and capping the liability of any shareholder for such intentional fraud to the actual proceeds received from the transaction by such shareholder and specifically waiving all other forms of fraud “whether intentional, reckless, negligent, constructive or otherwise.

Agreement and Plan of Merger, dated May 9, 2014, by and among Akorn, Inc., AkornEnterprises II, Inc., VPI Holdings Corp., and Tailwind Management LP, § 9.13, at 74, http://us.practicallaw.com/0-568-3228.

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Non-Recourse

Purpose

� Limits the parties who can be held liable for obligations under the contract.

� Protects affiliates (shareholders, members, partners) of the contracting parties and officers and directors of the contracting parties.

� Works best when used as part of a comprehensive approach to contract drafting that considers all potential intrusions into the contractual arrangement from tort law.


Non-Recourse – Model Provision

No Recourse Against Nonparty Affiliates. All claims, obligations, liabilities, or causes of action (whether in contract or in tort, in law or in equity, or granted by statute)that may be based upon, in respect of, arise under, out or by reason of, be connected with, or relate in any manner to this Agreement, or the negotiation, execution, or performance of this Agreement (including any representation or warranty made in, in connection with, or as an inducement to, this Agreement), may be made only against (and are expressly limited to) the entities that are expressly identified as parties in the preamble to this Agreement (“Contracting Parties”).

No Person who is not a Contracting Party, including without limitation any director, officer, employee, incorporator, member, partner, manager, stockholder, Affiliate, agent, attorney, or representative of, and any financial advisor or lender to, any Contracting Party, or any director, officer, employee, incorporator, member, partner, manager, stockholder, Affiliate, agent, attorney, or representative of, and any financial advisor or lender to, any of the foregoing (“Nonparty Affiliates”), shall have any liability (whether in contract or in tort, in law or in equity, or granted by statute) for any claims, causes of action, obligations, or liabilities arising under, out of, in connection with, or related in any manner to this Agreement or based on, in respect of, or by reason of this Agreement or its negotiation, execution, performance, or breach; and, to the maximum extent permitted by law, each Contracting Party hereby waives and releases all such liabilities, claims, causes of action, and obligations against any such Nonparty Affiliates.


Non-Recourse – Model Provision (cont.)

Without limiting the foregoing, to the maximum extent permitted by law, (a) each Contracting Party hereby waives and releases any and all rights, claims, demands, or causes of action that may otherwise be available at law or in equity, or granted by statute, to avoid or disregard the entity form of a Contracting Party or otherwise impose liability of a Contracting Party on any Nonparty Affiliate, whether granted by statute or based on theories of equity, agency, control, instrumentality, alter ego, domination, sham, single business enterprise, piercing the veil, unfairness, undercapitalization, or otherwise; and (b) each Contracting Party disclaims any reliance upon any Nonparty Affiliates with respect to the performance of this Agreement or any representation or warranty made in, in connection with, or as an inducement to this Agreement.


Other Traps for the Unwary

� When not drafted carefully, a governing law provision can have unintended consequences


Governing Law

� Purpose:

Governing law provision sets forth what state’s law will govern the interpretation of the agreement.

Jurisdiction / forum provision sets forth where the parties will litigate contract disputes.

� Items to Consider:

Governing Law

Application of a state’s law to a contract typically requires some relationship between the contract and such state; check applicable state’s law for specific requirements.

Consider the sophistication and depth of the contract law selected to govern the agreement.

A governing law provision does not necessarily determine which law will govern the applicable statute of limitations that will govern a claim based upon the contract containing such provision.

To ensure that a selected state’s law will actually govern all disputes related to the agreement, it is critical to specify that the governing law applies to disputes arising in contract and in tort.


Governing Law – Model Provision

� This Agreement, [list related documents], and any other document or instrument delivered pursuant hereto, and all claims or causes of action (whether in contract or tort)that may be based upon, arise out of or relate to this Agreement or the negotiation, execution, termination, performance or nonperformance of this Agreement (including any claim or cause of action based upon, arising out of or related to any representation or warranty made in or in connection with this Agreement or as an inducement to enter into this Agreement), shall be governed by the internal laws of the State of [_____], without regard to its conflicts of law principles.


Further Reading

� Glenn D. West, That Pesky Little Thing Called Fraud: An Examination of Buyer’s

Insistence Upon (and Sellers’ Too Ready Acceptance of) Undefined “Fraud

Carve-Outs” in Acquisition Agreements, 69 Bus. Law. 1049 (2014)

� Glenn D. West & Natalie A. Smeltzer, Protecting the Integrity of the Entity-

Specific Contract: The "No Recourse Against Others" Clause--Missing or

Ineffective Boilerplate?, 67 Bus. Law. 39 (2011)

� Glenn D. West & W. Benton Lewis, Jr., Contracting to Avoid Extra-Contractual

Liability—Can Your Contractual Deal Ever Really Be the "Entire" Deal?, 64 Bus.

Law. 999 (2009)

� Glenn D. West & Kim Shah, Debunking the Myth of the Sandbagging Buyer:

When Sellers Ask Buyers to Agree to Anti-Sandbagging Clauses, Who Is

Sandbagging Whom?, (January 2007, The M&A Lawyer)

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