August 27, 2020

Del. Chancery Refuses to Dismiss Fraud Claims Tied to Breach of Rep

One of the things that buyers worry most about is the seller’s loss of a major customer between signing and closing. That’s why acquisition agreements contain reps & warranties addressing the status of major customer relationships and provide assurances that the seller has no knowledge of any adverse developments affecting those relationships. If the buyer discovers a breach of that rep after the closing, the seller may be obligated to indemnify the buyer for the damages resulting from it.

Those damages are ordinarily limited by the negotiated caps & baskets provided for in the agreement’s indemnification provisions. But there’s often a fraud carveout that applies to those limits, and in Swipe Acquisition v. Krauss, (Del. Ch.; 8/20), the Delaware Chancery Court provided a reminder that in the case of a seller’s knowing breach of a rep, the buyer may be able to make out a fraud claim based on that breach.

The case involved allegations that the seller’s management knew that it would lose business from a major customer in advance of signing a purchase agreement that included a fairly typical major customers rep.  Vice Chancellor Fioravanti not only refused to dismiss the buyer’s breach of contract claim, but also held that the buyer stated a claim for fraud.  Among other things, he rejected the defendants’ claim that the buyer was attempting to “bootstrap” a breach of contract claim into a fraud claim:

A contracting party may not “bootstrap” a breach of contract claim into a fraud claim “merely by adding the words ‘fraudulently induced’ or alleging that the contracting parties never intended to perform.” Iotex Comm’cns, Inc. v. Defries, 1998 WL 914265, at *5 (Del. Ch. Dec. 21, 1998). Generally, the anti-bootstrapping rule applies when a plaintiff attempts to transmute a breach of contract claim into a fraud claim by adding conclusory allegations to its breach of contract allegations. See Smash Franchise P’rs, LLC v. Kanda Hldgs., Inc., 2020 WL 4692287, at *16  (Del. Ch. Aug. 13, 2020) (“A bootstrapped fraud claim thus takes the simple fact of nonperformance, adds a dollop of the counterparty’s subjective intent not to perform, and claims fraud.”).

Swipe is not bootstrapping its breach of contract claim into a fraud claim. Contractual representations may form the basis for a fraud claim where a plaintiff has alleged facts “sufficient to support a reasonable inference that the representations were knowingly false.” Prairie Capital, 132 A.3d at 62. Thus, the anti-bootstrapping rule does not apply where a plaintiff has made particularized allegations that a seller knew contractual representations were false or lied regarding the contractual  representation, or where damages for plaintiff’s fraud claim may be different from plaintiff’s breach of contract claim.

This is the second Delaware decision in less than a month to address fraud claims based on breach of reps in a purchase agreement. As in the recent NGP X U.S. Holdings case, the purchase agreement here also included a fraud disclaimer, and the defendants tried to use that disclaimer to preclude the plaintiff’s fraud claim. The Vice Chancellor quickly disposed of that argument, observing that fraud claim was primarily based on the language of the target’s express reps & warranties, which the anti-reliance clause of the agreement specifically permitted the plaintiff to rely upon.

John Jenkins