January 30, 2019

Liability Caps: Beware Undefined Fraud Carve-Outs

This recent blog from Weil’s Glenn West uses the Delaware Chancery Court’s recent decision in Great Hill Equity Partners v. SIG Growth Fund (Del. Ch.; 11/18) – which I blogged about last month – as a jumping-off point for a discussion of the perils of undefined fraud carve-outs to contractual liability caps.

Glenn points out that while the shareholders in Great Hill avoided liability beyond the contractual cap despite their CEO’s fraud, other selling shareholders haven’t fared as well.  In at least one case, selling shareholders have found themselves litigating their responsibility for another shareholder’s fraud for years due to uncertainties about the scope and application of an undefined fraud carve.  Even worse – as this excerpt points out – this issue may just be the tip of the iceberg:

It is important to note that the issue of whose fraud matters, in uncapping the liability-limitation regime, is literally just the tip of the iceberg of perils that undefined fraud carve-outs pose.  The number of other, just under-the-surface, hazards that can do serious damage to your carefully crafted and capped liability-limitation regime are legion.

They include issues as to what kind of fraud is actually being carved out (yes there are surprising forms of fraud that do not involve the deliberate conveyance of falsehoods), as well as whether the fraud carve-out encompasses fraud with respect to any statement made in the course of negotiation, or only with respect to those statements that the parties agreed were the bargained-for factual predicates for the deal and therefore important enough to incorporate into the written acquisition agreement.

The blog points out that it has become established market practice to define fraud carve-outs so that only intentional misrepresentations by a particular seller relating to the specific representations and warranties in the agreement are carved out from the liability cap.

John Jenkins