February 1, 2021

Officer Liability: Del. Court Refuses to Dismiss Fraud Claims Against LLC Managers

In Surf’s Up Legacy Partners, LLC v. Virgin Fest, LLC, (Del. Super. 1/21), the Delaware Superior Court rejected efforts by a seller’s managers to dismiss the buyer’s fraud claims against them – despite the seller’s efforts to limit liability through exclusive remedy & non-recourse provisions in the purchase agreement. In a recent blog about the decision, Weil’s Glenn West points out that the absence of a non-reliance provision played a key role in the outcome – and that all three provisions are necessary to mitigate the risk of fraud claims.

The buyer’s fraud claims against the seller’s managers were aided by the language of the fraud carve-out itself. The carve-out to the agreement’s exclusive remedy provision didn’t limit the sources of alleged misrepresentations that could serve as the basis for a fraud claim, and applied not just to fraud by one of the parties to the deal, but by any person – including specifically “an officer or manager of any Seller or Buyer in connection with the consummation of the transactions contemplated by this Agreement.”

Despite the language of the fraud carve-out, the seller pointed to the provisions of the non-recourse clause – which contained no such carve-out – and said that the buyers were to have no recourse to the seller’s managers for any claims arising under or related to the purchase agreement. They contended that this language trumped the fraud carve-out to the deal’s exclusive remedy clause.

As this excerpt from the blog explains, not only did the court not buy that argument, it said there was nothing that the parties could do by contract to insulate anyone from intentional fraud claims:

The human manager defendants asserted that the nonrecourse clause trumped the exclusive remedy clause’s Fraud carve-out. Not so said the court—the exclusive remedy provision stated that “nothing herein shall … preclude any party from seeking any remedy against any Person based upon Fraud by any other Party.” And according to the court, the “herein” referred to was the entire APA, not just the exclusive remedy provision itself; thus, the exclusive remedy provision’s Fraud carve-out trumped the non-recourse provision: “while the parties generally agreed the No Recourse Provision would bar ‘tort’ claims against the Managers, they also expressly agreed the APA would not bar the bringing of fraud claims.”

But importantly for our purposes, the court went further and stated that the parties “could not have contacted otherwise … [because] Delaware courts refuse to enforce contracts purporting to condone—or at least insulate—intentional fraud.” The court thus suggested that, even if the exclusive remedy provision’s fraud carve-out had not been deemed to have trumped the nonrecourse clause’s bar on tort claims against nonparty human agents of the entity parties, an intentional fraud claim could still have been brought against the human managers of the selling entity party to the APA based on Delaware public policy.

The blog says that this result shouldn’t come as a surprise to anyone familiar with the Chancery Court’s decision in Abry Partners, and points out that in Delaware, the one fraud claim that an exclusive remedy provision can’t be drafted to eliminate “the [s]eller’s exposure for its own conscious participation in the communication of lies to the [b]uyer” in the written agreement itself. The blog points out that the asset purchase agreement in this case lacked an important third leg necessary to maximize the protection available to individuals – a non-reliance provision:

Unlike exclusive remedy provisions and nonrecourse clauses, there do not appear to be any Delaware public policy exceptions to the effectiveness of a well-crafted and properly placed non-reliance clause. There was no non-reliance clause in the APA being considered in Surf’s Up Legacy Partners; thus both extra-contractual and intra-contractual fraud claims were at play.

In order to effectively mitigate the risk of “untethered fraud claims,” the blog says that all three of these provisions “need to work together against knowledge of the public policy restrictions on their full effectiveness.”

John Jenkins