How should a court apply an indemnity carve-out that provides for uncapped damages for fraud to selling shareholders who weren’t participants in the fraud? That’s the question the Delaware Chancery Court was recently called upon to answer in Great Hill Equity Partners v. SIG Growth Equity Fund, (Del. Ch.; 11/18).
In a 153-page opinion, Vice Chancellor Glasscock held that the former CEO of e-commerce firm Plimus was liable for fraud in connection with its 2011 sale, and that he & the selling PE investors also made several knowing, but immaterial misrepresentations, during the due diligence process. The Vice Chancellor found that the CEO’s misconduct resulted in breaches of the purchase agreement, but as this Goodwin memo explains, he limited the selling shareholders’ liability to the indemnity cap established in the agreement:
With respect to the indemnification liability, the Court found breaches of the merger agreement’s representations and warranties that Plimus had complied with operating rules of the major credit card associations and that no payment-processing supplier had notified Plimus that it intended to terminate its business relationship. As a result, the Court concluded that Great Hill is entitled to indemnification up to the sellers’ pro rata share of the escrow amount provided for in the merger agreement.
The Court also held that, even though there was fraud in the transaction and the merger agreement limited the sellers’ indemnification obligations “except . . . in the case of fraud or intentional misrepresentation (for which no limitations set forth herein shall be applicable),” the limitation on liability protected the selling stockholders – who themselves were not liable for fraud – from indemnification beyond the escrow.
The selling shareholders aren’t out of the woods yet – the case also includes an unjust enrichment claim against them upon which the court deferred judgment until the parties briefed the amount of damages at issue.
– John Jenkins