Justin M. Forcier, an associate in the Delaware office of Eckert Seamans, prepared this overview.

A recent Chancery decision provides guidance regarding when the decision by an independent party appointed to resolve post-closing adjustments can be used as an arbitration award that can be turned into a judgment of the court.  Fraud claims in the context of a non-reliance clause are also addressed.  EMSI Acquisition, Inc. v. Contrarian Funds, LLC, et al., C.A. No. 12648-VCS (Del. Ch. May 3, 2017).

Background:  In 2005, Defendants acquired their interests in EMSI Holding Company (“EMSI” or the “Company”) through a non-judicial restructuring in 2005.  After several unsuccessful attempts to sell their interests in EMSI, in 2015, Defendants circulated a Confidential Information Memorandum (“CIM”) to potential buyers.  The CIM contained an optimistic outlook for EMSI despite its historic financial difficulties.

Plaintiff EMSI Acquisition, Inc. (“Plaintiff”) entered negotiations to purchase the Company.  Defendants used the reported EBITDA of $10.2 million for the trailing 12 months, and Plaintiff purchased EMSI from Defendants for $85 million based on that calculation.

However, after the closing, Plaintiff alleges to have discovered that the Company’s projections were greatly overstated and the financials were manipulated to appear more profitable.  Plaintiff asserted two claims against Defendants: (i) that the contractual limits on indemnification in the SPA should be disregarded based on Defendants’ fraudulent representations; and (ii) the findings of an independent auditor should be confirmed by the court as an arbitrator’s award pursuant to the Delaware Arbitration Act.

Court’s Holding:  The court declined dismissal of Plaintiff’s fraud allegation.  The SPA was ambiguously drafted regarding the level of risk Plaintiff assumed in the purchase and it had adequately pled fraud pursuant to Rule 9.

However, the court held that the auditor’s findings could not be confirmed as an arbitration award because that would be contrary to the plain language of the agreement.

Analysis:  First, the court stated that dismissal would only be appropriate for Plaintiff’s fraud claim if the SPA’s risk allocation could only be interpreted one way.  The SPA contained a non-reliance clause that disclaimed any reliance on extra-contractual actions—except in the case of fraud.  However, Defendants pointed to a “notwithstanding clause” that they argued removed the limitations on indemnification for fraudulent actions for extra-contractual actions.  Any fraud within the four corners of the document, Defendants argued, was capped by the non-reliance clause.

Instead, Plaintiff pointed to a competing notwithstanding clause and argued that this more-specific notwithstanding clause that expressly disclaims ‘“all limitations on remedies or recoveries”’ must prevail over the more general notwithstanding clause.  Noting the SPA’s inconsistency, the court concluded that the SPA is ambiguous and dismissal was not appropriate pursuant to Rule 12(b)(6).

Next, the court held that Plaintiff properly pled fraud pursuant to the heightened standard of Rule 9.  Plaintiff was able to plead knowledge of the alleged fraud by providing a chart in the complaint that listed the names and/or titles of each person who made a fraudulent statement, the alleged statement or action by each person or entity, and the dates of those statements or actions.  The court held that since Plaintiff was able to adequately plead knowledge, the rest of the requirements for fraud were easily met.

Nonetheless, the court dismissed Plaintiff’s second claim that the findings by an independent auditor should be confirmed as an arbitration award.  The SPA contained language that said a Settlement Auditor would resolve any disputes regarding the calculation of net working capital.  And although Delaware law favors arbitration, parties cannot be forced to arbitrate the merits of their claims.

The SPA specifically states a Settlement Auditor would be ‘“acting as an expert and not an arbitrator.”’ Therefore, any holdings that confirmed the independent auditor’s findings as an arbitration award would violate the plain language of the SPA, and the court dismissed count II of Plaintiff’s complaint.