Anvil Holding Corp. v. Iron Acquisition Co., C.A. No. 7975-VCP (May 17, 2013).
Issue: Motion to dismiss a complaint for fraud and bad faith breach of contract in a dispute for the sale of securities.
Answer: Denied as to the fraud claim and granted as to bad faith breach of contract claim.
This is a dispute where the buyer, Iron Acquisition Corp., subsequent to the sale of securities, allegedly discovered that it was defrauded and claimed that it paid too much for the securities. The dispute about the ownership of escrowed funds arose out of a sale where Iron Acquisition Corp. purchased all of the seller’s, Iron Data Solutions, LLC, outstanding securities from its twenty-three security holders, which included the company’s management. The seller’s representatives filed suit in the Court of Chancery to compel disbursement of the escrowed funds and the buyer filed suit in the Superior Court alleging: (i) fraud on the part of the selling company‘s management; (ii) bad faith breach of contract by the selling company’s management; and (iii) breach of contract by the sellers’ representatives in their capacity as representatives of all the sellers based on alleged misrepresentations the company made in the purchase agreement. The cases were consolidated into the Court of Chancery action.
The sellers’ representatives moved to dismiss the buyer’s complaint contending that: (i) the buyer’s fraud claim was not pled with particularity; (ii) the fraud claim was precluded by the language of the purchase agreement; and (iii) the buyer failed to follow the purchase agreement’s stated procedural requirements for bringing a claim for breach of that agreement.
Positions of the Parties
The buyer’s main allegation concerned the future of one of the seller’s most important contracts with Lockheed. The buyer alleged that the individual defendants knew that the contract with Lockheed soon would change from a “firm fixed price” basis to a materially lower “time and materials” basis. In the purchase agreement, Iron Data had represented and warranted that “no contractor . . . has notified the Company or any Company Subsidiary in writing (or, to the Knowledge of the Company, orally) of any intention to stop, materially decrease the rate or materially change the terms (whether related to payment, price or otherwise) with respect to buying or supplying as the case may be, materials, services, or products.” The agreement defined “Knowledge” to mean all facts actually known by, among others, the individual defendants.
The buyer alleged that the individual defendants: (1) knew that Lockheed intended to change the pricing; (2) negotiated new pricing rates with Lockheed; (3) deliberately hid this information from the Buyer; and (4) delayed making any official arrangements with Lockheed until the transaction had closed to induce the buyer to purchase Iron Data based on the false assumption that the Lockheed contract would continue on the disclosed basis.
With respect to whether the fraud claims was pled with particularity, the Court focused its analysis on two issues: (i) whether the defendant falsely represented or omitted facts that the defendant had a duty to disclose; and (2) whether the defendant knew or believed that the representation was false or made the representation with a reckless indifference to the truth. The Court pointed to where the complaint alleged that meetings took place on March 17 and May 9, 2011, and that each individual defendant attended one or both of those meetings. In particular, the Court noted that at one of the meetings, three of the individual defendants allegedly participated in a conference call and representatives of the buyer asked “whether there was any prospect of time and materials work and the potential rates the Company would charge for such work”, and the three individual defendants “failed to disclose their discussions with Lockheed regarding the time and materials rates and represented that the Lockheed Agreement would continue on a firm fixed price basis.” These allegations provide the time, place, and contents of the alleged representation or omission. As to whether the defendants knew or believed that the representation was false, the Court found that they did and pointed to an email that one of the defendants was a party to which stated “we have not mentioned this to [the buyer] and they have asked about it.”
The sellers also argued that the complaint failed to state a claim for fraud against the individual defendants based on the company’s representations in the purchase agreement. Relying on a transcript ruling in M/C Venture Partners V, L.P. v. Savvis, Inc., C.A. No. 7359-VCL (Del. Ch. Jan. 17, 2013), the defendants argued that the individual defendants could not be held liable for fraud based on the falsity of the purchase agreement because those representations were made by the Company, not the Individual. The Court disagreed noting:
[h]ere, the Individual Defendants being accused of fraud were both sellers and managers of the Company. They also are the individuals whose knowledge allegedly makes the representations in Section 3.25 [of the Purchase Agreement] false. Importantly, and unlike the facts in M/C Venture Partners, the Complaint further alleges particular facts tying each Individual Defendant to the alleged fraud. Based on the well-pled allegations in the Complaint, it is reasonably conceivable that Plaintiff could prove that the Company‘s representations in Section 3.25 were false when made and that the Individual Defendants not only knew the Company was making false representations and warranties, but actively concealed from the Buyer information that made those representations false. Furthermore, the Individual Defendants allegedly were the senior management of Iron Data. They attended meetings with the Buyer about the Transaction, including a meeting on the day of closing. The Complaint also avers that it was important to Defendants to conceal from the Buyer Lockheed‘s intention to use time and materials rates. The allegations regarding the Individual Defendants’ active concealment of Lockheed’s intention, coupled with their participation in meetings leading up to the closing, are sufficient to make it reasonably conceivable that the Individual Defendants caused the Company to make a false representation in the Purchase Agreement.
Finally, the sellers argued that the purchase agreement precluded the buyer from bringing claims for fraud based on off-contract representations because the buyer said that “it was not relying on extra-contractual statements in deciding to enter into the Agreement.” However, the Court found that the buyer had not disclaimed reliance upon extra-contractual statement noting:
Delaware courts will honor clauses in which sophisticated parties disclaim reliance on extra-contractual representations. This Court, however, will not “give effect to so-called merger or integration clauses that do not clearly state that the parties disclaim reliance upon extra-contractual statements.” In order to bar a claim for fraud based on extra-contractual fraudulent representations, “[t]he integration clause must contain language that can be said to add up to a clear anti-reliance clause by which the plaintiff has contractually promised that it did not rely upon statements outside the contract‘s four corners in deciding to sign the contract.”
I do not find that Sections 3.27 and 10.9 of the Purchase Agreement 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 into the Agreement. The Sections just quoted do not state that the parties disclaim reliance upon extra-contractual statements. They indicate that the Company represented that neither it nor any Seller was ‘making any other express or implied representation or warranty with respect to the Company’ and that the Purchase Agreement constitutes the entire agreement of the parties. The Buyer‘s fraud claim is not precluded by this promise. That is, there is no ‘double liar’ problem where allowing the Buyer to prevail on its fraud claim would sanction its own fraudulent conduct in having falsely asserted that it was relying only on contractual representations. In addition, the parties to this Purchase Agreement agreed to ‘reserve all rights with respect to’ any claims based on fraud or the bad faith of any party. Thus, other language in the Purchase Agreement provides further evidence that the parties intended that fraud claims could be based on extra-contractual representations. For both of these reasons, it is reasonably conceivable that Plaintiff can prevail on its claim for fraud predicated in part on extra-contractual representations.
As a result, the Court denied that motion to dismiss the fraud count of the complaint. The Court also concluded that with respect to breach of contract and bad faith breach of contract claims in Count II, the buyer had stated a claim for breach of contract but not a claim for bad faith breach of contract. The court also noted that the “buyer’s failure to name all sellers as defendants warrants dismissal of its breach of contract claim without prejudice to its ability to amend the complaint in that regard.”