Projections about a portfolio company’s financial performance are a customary part of any private equity investment, but because the parties involved are sophisticated and reliance upon projections is usually disclaimed in the purchase agreement, sellers often discount the liability risks associated with them. The Chancery Court’s recent decision in In re P3 Health Group Holdings, (Del. Ch.; 10/22), is a reminder that even with sophisticated investors & reliance disclaimers, faulty projections remain fair game for fraud claims.
The case arose out of a follow-on investment in a portfolio company controlled by a private equity fund. The investor alleged that it was fraudulently induced to make its investment based on inflated EBIDTA projections. According to the complaint, those projections showed that the company would generate more than $12 million in EBITDA in 2020. Instead, the company generated negative $40 million in EBITDA for that year. Yeah, that’s a, uh, pretty big miss – and in Vice Chancellor Laster’s view, its magnitude supported a pleading stage claim that the projection was knowingly false:
The fact that a projection does not come to fruition, standing alone, often will be “legally insufficient to support a fraudulent inducement claim.” See Edinburgh Hldgs., 2018 WL 2727542, at *12. That is because “allegations of fraud by hindsight are not enough to state a cognizable claim of misrepresentation . . . .” Noerr v. Greenwood, 1997 WL 419633, at *5 (Del. Ch. July 16, 1997) (internal quotations omitted). But that does not mean that a court cannot consider the failure to meet a projection when evaluating whether a plaintiff has pled facts supporting an inference that the projection was knowingly false.
The fact that a business has missed a near-term projection by a large margin supports several possible inferences. Many of those inferences are innocent. Perhaps the nature of the business made forecasting difficult. Perhaps an external event affected the outcome. But at least one possible inference is that the near-term projection was knowingly false. At the pleading stage, Hudson is entitled to the inference that is favorable to its claim.
By now, you’re probably wondering whether there was a reliance disclaimer in the purchase agreement that covered the projections. The answer is that there was, but it included a fraud carve-out that excluded from the disclaimer “claims or allegations arising from or relating to fraud or intentional misrepresentation.” Along the same lines, Vice Chancellor Laster rejected the defendants’ claims that a standard integration clause providing that the transaction documents represented the parties’ entire agreement and “supersede and preempt any prior understandings, agreements or representations by or among the parties hereto” was sufficient to preclude fraudulent inducement claims.
The opinion also provides a useful overview of the elements of a fraudulent inducement claim, and the Vice Chancellor walks through the application of each of them to the factual allegations in the complaint. What’s really remarkable though is that VC Laster accomplishes all of this in an opinion that’s less than 17 pages in length – which may be a personal best for him in terms of brevity!
– John Jenkins