Abry Partners V, L.P. v. F & W Acquisition LLC
2006 Del. Ch. LEXIS 28, 2006 WL 358236, 891 A.2d 1032 (2006)
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Rule of Law:
While sophisticated parties can contractually limit liability for misrepresentations that are innocent, negligent, or even reckless, Delaware public policy forbids a contractual provision from insulating a party from rescission or damages for its own intentional and fraudulent misrepresentations.
Facts:
- Providence Equity Partners (Seller), a private equity firm, owned F & W Publications (the Company) and decided to sell it through an auction.
- Another private equity firm, ABRY Partners (Buyer), expressed interest in purchasing the Company, indicating its offer would be based on the Company's EBITDA (a measure of profitability).
- The parties negotiated and executed a Stock Purchase Agreement for the sale of the Company to the Buyer for $500 million.
- The Agreement contained specific representations and warranties regarding the Company's financial condition, but also included an exclusive remedy provision limiting the Seller's liability for any misrepresentation to a $20 million indemnity fund.
- The Agreement also contained a non-reliance clause, stating the Buyer was only relying on the representations made within the contract itself.
- After the acquisition closed, the Buyer discovered what it alleged were widespread, intentional accounting manipulations (such as 'channel stuffing' and 'backstarting') and other operational failures that had artificially inflated the Company's reported financial performance.
- The Buyer asserted that the Company's true value was significantly less than the $500 million purchase price and that it had been fraudulently induced to enter the contract.
- The Buyer requested that the Seller rescind the transaction and return the purchase price, but the Seller refused.
Procedural Posture:
- A group of entities affiliated with ABRY Partners (Buyer) filed a lawsuit against entities owned by Providence Equity Partners (Seller) in the Delaware Court of Chancery.
- The Buyer's complaint asserted claims for fraudulent inducement and negligent misrepresentation, seeking rescission of the Stock Purchase Agreement or, in the alternative, damages.
- The Buyer was granted permission to amend its complaint to premise its claims solely on misrepresentations within the Stock Purchase Agreement itself.
- The Seller filed a motion to dismiss the amended complaint under Court of Chancery Rule 12(b)(6) for failure to state a claim, arguing the exclusive remedy provision in the contract barred the suit.
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Issue:
Does Delaware public policy permit a contractual provision in a stock purchase agreement to bar a rescission claim and limit a buyer's remedy to a capped indemnity fund when the buyer alleges that the seller intentionally misrepresented facts contained within the agreement?
Opinions:
Majority - Strine, Vice Chancellor
No, Delaware public policy does not permit a contractual provision to bar a rescission claim or otherwise limit liability for a seller's own intentional, fraudulent misrepresentations. While parties are free to allocate the risk of unintentional factual errors, public policy will not enforce a contract that purports to shield a party from liability for its own conscious lies. The court reasoned that there is a fundamental moral and practical distinction between an unintentional misrepresentation and a deliberate lie. Sophisticated parties can contractually decide who bears the risk of mistakes, negligence, or even recklessness. However, the venerable public policy against fraud overrides freedom of contract when a party knowingly lies about a material fact represented within the contract. Therefore, the exclusive remedy provision is unenforceable to the extent it would prevent the Buyer from seeking rescission or full damages for the Seller's own intentional fraud. The Buyer's claims may proceed, but only insofar as it can prove the Seller knew its representations were false.
Analysis:
This decision establishes a critical boundary for freedom of contract in sophisticated M&A transactions under Delaware law. It affirms the validity of non-reliance clauses (barring claims on extra-contractual statements) and allows parties to cap liability for unintentional misrepresentations. However, it carves out a fraud exception, holding that a party cannot contractually obtain a 'license to lie' about facts represented within the agreement. The ruling provides clarity and predictability for dealmakers by drawing a bright line at intentional fraud, balancing the state's policy of contractual freedom with its strong public policy against fraudulent conduct. Future cases involving claims of misrepresentation in M&A will hinge on the seller's state of mind, with buyers needing to prove intentional deceit to overcome contractual remedy limitations.
