DealLawyers.com Blog

As I’ve mentioned before, cases dealing with disclosure schedules are like catnip to me, and those schedules featured prominently in the Chancery Court’s recent decision in SAM 1 Aggregator v. Mars Holdco, (Del. Ch.; 8/25).  In that case, Chancellor McCormick cited the seller’s disclosure letter delivered in connection with the parties’ stock purchase agreement in rejecting the buyer’s post-closing fraud and aiding and abetting allegations.

The stock purchase agreement included a provision disclaiming any representations and warranties not contained in Section 2.2 of the agreement and an explicit reliance disclaimer from buyer with respect to any reps & warranties not contained in the agreement.  The agreement also provided that the buyer could only bring claims for breaches of the reps & warranties “based on an actual and intentional fraud with respect to any statement in any representation or warranty made by [the seller].”

After the closing, the buyer discovered what it contended were undisclosed internal controls issues and undisclosed liabilities at the target relating to the migration of its credit card services business to Amazon Web Services (AWS). It filed a lawsuit asserting a fraud claim against the seller and aiding and abetting claims against the seller’s controlling stockholder based on alleged breaches of “Accounting Process Representations” with respect to the adequacy of its internal controls and a “Liabilities Representation” concerning the absence of undisclosed liabilities contained in Section 2.2 of the stock purchase agreement.

The buyer’s fraud allegations relating to the Accounting Process Representations centered on information contained in demand letter sent by counsel for the target’s former CAO Peter Owino.  The demand letter claimed that the former CAO had been instructed to improperly capitalize certain expenses in violation of GAAP and that his employment had been terminated in retaliation for raising these concerns. The buyer also alleged that the seller committed fraud by falsely representing that it had no undisclosed liabilities despite its knowledge of commitments associated with the AWS migration.

In rejecting these allegations, Chancellor McCormick cited the reliance disclaimer and language limiting contractual fraud claims to those “based on actual and intentional fraud” with respect to statements in the reps & warranties. She then noted that the buyer’s claims based on the Accounting Process Representation had a fatal flaw:

The problem with Buyer’s theory is that the parties expressly qualified the Accounting Process Representations by the allegations in the Owino Letter. Section 2.2(f)(iii) states that, “[s]ince January 1, 2019, except as set forth in Section 2.2(f)(iii) of the Disclosure Letter, [Seller] has not” identified deficiencies covered by the Accounting Process Representations. Section 2.2(f)(iii) of the Disclosure Letter identifies the “Peter Owino Matter” as an express limitation on the representations in Section 2.2(f)(iii) of the Purchase Agreement.  And the Disclosure Letter defines “Peter Owino Matter” as the “allegations against [Seller].”

The buyer tried to work around this problem by contending that the disclosure of the Peter Owino Matter should be construed to apply to employment issues only, and that the seller didn’t adequately disclose the demand letter’s “allegations of pervasive accounting improprieties.”  The Chancellor dismissed this argument by asking “why would Seller expressly qualify its Accounting Process Representations with reference to something that was solely an employment matter?”

Chancellor McCormick also noted that the “Peter Owino Matter” was referenced a total of five times in the stock purchase agreement, further undercutting the buyer’s fraud allegations.  With respect to the claims surrounding the AWS migration, she concluded that the estimated costs associated the future AWS migration weren’t “liabilities” as of the closing, and dismissed that claim as well.

– John Jenkins