Drafting Matters: Non-Reliance Provisions Barring Extra-Contractual Fraud Claims Effective in Delaware Only if Drafted as a Clear Statement by the Aggrieved Party
- FdG Logistics LLC v. A&R Logistics Holdings, Inc. (Del. Ch. 2016) reaffirms that in Delaware a contracting party will only be prevented from asserting claims for fraud based on representations outside the four corners of the contract if it makes an unambiguous disclaimer of reliance.
- Commonly used statements of limitation from a party making representations and warranties and integration or merger clauses (providing that the agreement represents the entire agreement of the parties and supersedes any prior agreements) will NOT suffice to bar common law claims for extra-contractual fraud, unless the language contains an affirmative statement of non-reliance from the aggrieved party.
- The right party must disclaim reliance for the disclaimer to be effective: The language of an anti-reliance provision need not contain any “magic” language, but it must be written as an affirmative statement from the point of view of the aggrieved party.
It is not unexpected for there to be requirements in consumer contracts that clear formulations of waivers are necessary before a consumer can be deprived of rights. However, under Delaware law similar formality and clarity is necessary in order to divest a sophisticated acquirer of a business, as well as parties to commercial contracts, the ability to rely on extra-contractual representations. Purchase agreements frequently contain provisions that a party is only making the representations contained in the agreement and the counterparty may not rely on any other statements. For the second time in two months, the Delaware Chancery Court has ruled that such statements are ineffective unless the counterparty makes its own clear acknowledgement of non-reliance on extra-contractual statements.
The Delaware Court of Chancery in FdG Logistics LLC v. A&R Logistics Holdings, Inc. (Del. Ch. 2016) clarified recent case law and noted that, although the 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 on its face, it is in fact substantively critical. This decision has important implications and should be carefully considered by practitioners when drafting non-reliance and integration provisions.
Background of the Case
In FdG Logistics, the seller sought to dismiss allegations of fraud made pursuant to counterclaims by the buyer. Among the counterclaims asserted by the buyer was for a claim based on common law fraud arising out of certain alleged extra-contractual misrepresentations made to the buyer before it entered into the merger agreement (the “Agreement”). The sellers then sought to dismiss this claim, relying upon an anti-reliance provision and integration clause in the Agreement.
The relevant provisions include:
- a non-reliance provision at the end of the company’s representations and warranties, stating that the company made no representations or warranties except for those expressly set forth therein;
- an integration clause, stating that the Agreement constitutes “the entire agreement between the [p]arties and supersedes any prior understandings, agreements or representations by or between the [p]arties . . .”; and
- a provision stipulating that the indemnification rights under the Agreement are the parties’ sole remedies with respect to the subject matter of the Agreement, other than with respect to fraud or intentional breach.
The Court’s Analysis and Holding
Chancellor Bouchard denied the sellers’ motion to dismiss, finding that the Agreement did not contain “an affirmative disclaimer of reliance by [the] Buyer sufficient to preclude it from asserting a claim for fraud based on representations outside the four corners of the [Agreement] under this Court’s precedents.” FdG Logistics adds color to recent precedent established by the Delaware Court of Chancery regarding fraud claims and anti-reliance language, holding that, although no “magic” words are required, the language of an anti-reliance provision must be written as a statement from the aggrieved party and not simply as a disclaimer given by the party making the representations and warranties.
In their motion to dismiss the buyer’s claim of common law fraud, the sellers argued that the non-reliance provision and integration clause in the Agreement precluded the buyer, as a matter of law, from establishing that it justifiably relied on any pre-merger representations.
In denying the sellers’ motion, the Court relied on its decision in Abry Partners V, L.P. v. F&W Acquisition LLC (Del. Ch. 2006), holding that the Court “will not insulate a party from liability for its counterparty’s reliance on fraudulent statements made outside of an agreement absent a clear statement by that counterparty—that is, the one who is seeking to rely on extra-contractual statements—disclaiming such reliance” (emphasis added). In other words, the non-reliance language must be stated from the point of view of the party receiving the representations, and not—as was the case in FdG Logistics— merely as a disclaimer from the party making the representations.
To exemplify the precedent laid down by Abry and its progeny, the Court first looked to Anvil Hldg. Corp. v. Iron Acquisition Co., Inc. (Del. Ch. 2013), in which Vice Chancellor Parsons denied a motion to dismiss a fraud claim arising out of extra-contractual statements on the basis that the provisions at issue were not expressed from the point of view of the buyer, and thus did not “reflect a clear promise by the Buyer that it was not relying on statements made to it outside of the Agreement to make its decision to enter the Agreement” (emphasis added).
FdG Logistics further illustrates the analysis in Anvil by analyzing the Court’s more recent decision in Prairie Capital III, LP v. Double E Holding Corp. (Del. Ch. 2015), in which Vice Chancellor Laster dismissed fraud claims based on extra-contractual representations. The critical distinction in Prairie Capital was that, unlike in Anvil, the “provisions at issue reflected an affirmative expression by the aggrieved buyer that it had relied only on the representations and warranties in the purchase agreement . . .” Notably, the FdG Logistics Court took care to reiterate that it does not matter whether the language is framed negatively or positively (i.e., it does not matter if the buyer acknowledges that it only relied on the representations and warranties expressly set forth in the Agreement or if the buyer states that it has not relied on any representations or warranties other than those of seller expressly set forth in the agreement), and that Anvil does not require specific language requiring that a party state that it “disclaims reliance” for a non-reliance provision to be enforceable: “Delaware law does not require magic words” (quoting Prairie Capital).
The Court acknowledged that a disclaimer from the point of view of a party accused of fraud and one from the point of view of a party who believes it has been defrauded may seem “like two sides of the same coin,” but emphasized that because of the strong public policy against fraud, it is important that the allegedly defrauded party clearly make the statement limiting its recourse to an extra-contractual fraud claim.
To be enforceable as a matter of Delaware law1, non-reliance provisions therefore need to be drafted from the point of view of the aggrieved party. Thus, practitioners should take care when negotiating a contract with a non-reliance provision, to ensure that the language is formulated to convey clearly that the counterparty is affirmatively not relying on any extra-contractual statements or omissions.
1) The analysis of enforceability of non-reliance provisions differs under federal securities laws, pursuant to which there is a private cause of action under § 10(b) and Rule 10b-5 of the Securities and Exchange Act of 1934 (the “Act”). There is a split in the Circuit courts as to whether § 29(a) of the Act forbids enforcing non-reliance provisions, as a matter of law, as a bar on Rule 10b-5 claims. The Second and Seventh Circuits have held that non-reliance provisions can generally act as a bar Rule on 10b-5 claims, while the First and Third Circuits have held that non-reliance provisions in and of themselves cannot act as bar on Rule 10b-5 claims, as doing so would violate § 29(a) of the Act. All four Circuits agree, however, that reliance is an essential prong of a Rule 10b-5 claim, and that the existence of a well-drafted non-reliance provision and integration clause will be considered when deciding whether a plaintiff reasonably relied on any extra-contractual statements or omissions.