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The Delaware Chancery Court recently provided a reminder to those drafting acquisition agreements that if you want to create a contractually binding obligation, the recitals section of the agreement isn’t generally the place to do it.  In Feeney Brothers Excavation Trust v. Artera Services, (Del. Ch.; 7/26), the Court rejected claims that a buyer breached the terms of an Equity Purchase Agreement by failing to provide what they alleged was an agreed upon dollar amount of rollover equity.

In support of its claim that the buyer had agreed that the rollover equity would have a specific dollar value, the plaintiffs’ pointed to the following definition contained in the recitals section of the Agreement:

“Rollover Amount” references “an aggregate value of $30,000,000,” used in the context of describing the value of the Contributed Units.

However, the recitals were the only section of the Agreement in which a specific dollar amount was referenced, and Judge Patricia Winston, sitting in Chancery by designation, concluded that wasn’t sufficient:

Plaintiffs’ theory fails because it seeks to impose obligations via the recitals. “Generally, recitals are not a necessary part of a contract and can only be used to explain some apparent doubt with respect to the intended meaning of the operative or granting part of the instrument.” Recitals may identify the meaning of terms via definitions or “provide background and . . . offer insight into the intent of the parties.”But a recital may “not establish a substantive obligation.” And “[i]f the recitals are inconsistent with the operative or granting part, the latter controls.”

While Judge Winston agreed with the plaintiffs that reference to the recitals was necessary to identify which units were transferred or issued in the rollover transaction, and that Section 1.1 of the agreement uses the terms defined in the recitals, she characterized the plaintiffs claims as an attempt “to transform the recital definitions into a guaranty or representation and warranty regarding the units’ ‘actual value.’”

She concluded that using the recitals in this way conflicted with the operative sections of the contract. Specifically, Judge Winston pointed to a representation from sellers acknowledging that there was “no representation or warranty. . . as to the . . .desirability or value of an investment in [the post-closing entity],” except for the representations set forth in Section 2 of the Agreement. This language, she said, precluded the plaintiffs from asserting that the language of the recitals constituted a representation concerning the value of their investment.

– John Jenkins