DealLawyers.com Blog

Earlier this month, I blogged about the Delaware Supreme Court’s decision in Paragon Metals Holdings v. Smith, (Del.; 7/26), in which the Court held that gaps in the buyers’ due diligence did not preclude them from relying on allegedly fraudulent representations from the seller.  This Mayer Brown memo discusses the decision. This excerpt addresses a few issues that I didn’t cover in my blog, the evidentiary standard applicable to fraud claims & the role of events that threaten the deal’s financing in establishing an MAE:

– Fraud claims are subject to the preponderance of the evidence standard—not a heightened clear and convincing evidence standard. The CEO argued that a “clear and convincing” evidentiary standard applies to fraud claims because fraud allegations carry moral stigma and can rest on circumstantial evidence. The Court rejected that argument and confirmed that ordinary civil preponderance remains the standard for Delaware fraud claims, noting that Delaware’s heightened pleading requirements already help screen out meritless claims.

– Events that threaten acquisition financing may help establish a material adverse effect. Proving an MAE remains difficult under Delaware law, so the trial court’s MAE finding is noteworthy. The “no MAE” representation was forward looking, and the trial court found it false because extensive changes to the target’s business with two major customers made it reasonably likely that the company would default on its acquisition financing and face bankruptcy. The Delaware Supreme Court affirmed that falsity finding because the CEO did not challenge the trial court’s conclusion.

The memo says that sellers should keep in mind that a forward-looking “no MAE” rep may require them to consider not only how the target operated prior to the closing, but also how any known adverse developments might affect the target after the closing given the buyer’s financing and capital structure. In other words, the memo says that “[t]he practical point is that sellers should assess forward-looking MAE representations against the real-world consequences of known adverse developments and disclose facts that could trigger those consequences.”

– John Jenkins