DealLawyers.com Blog

Last month, I blogged about the Delaware Supreme Court’s decision in the Paragon Metals case, in which the Court held that buyers reasonably relied on the seller’s reps & warranties for purposes of asserting a fraud claim despite shortcomings in the buyer’s due diligence process. Last week, in In Re Swervepay Acquisition, LLC, (Del. Ch.; 7/26), the Chancery Court reached a similar conclusion with respect to a seller’s fraud claims.

The litigation arose out of the acquisition of SwervePay, a payments facilitator (PayFac), by a portfolio company owned by private equity sponsors. The sponsors had previously acquired the portfolio company based on their belief that its software platform provided access to at least $34 billion of payment volume that could be monetized through a PayFac business. Those figures were repeatedly cited during the negotiations with the target, and it ultimately agreed to a deal structure that included substantial earnout payments tied to achieving that payment volume.

However, prior to the signing, the sponsors and their advisors learned that the actual potential payment volume was significantly lower than what was represented but did not disclose that fact to the target. After closing, it became clear that the earnouts were effectively unattainable, and the target’s former owners sued for fraudulent inducement.

In challenging the plaintiffs’ argument that their reliance on the buyers’ extracontractual representations about payment volumes was reasonable, the defendants pointed to alleged shortcomings in the target’s due diligence investigation and its failure to bargain for a contractual representation concerning payment volumes. Chancellor McCormick’s opinion first addressed the argument relating to the target’s due diligence:

Buyers quibble with Sellers’ diligence efforts. They raise arguments describing steps that Sellers could have taken instead of relying on the February 8 Email, including speaking to management, retaining advisors, or speaking with Durrett. But the court’s inquiry is not whether Sellers could have eventually discovered the truth had they continued to dig. The inquiry is whether Sellers’ reliance on the false representation was reasonable.

It was. Sellers inquired about Ontario’s monetizable payments volume several times.  Sellers then asked to see data allowing them to verify Buyers’ statements. . .

Here, Sellers did not seek diligence regarding the payments market generally. Rather, they sought information specific to [the portfolio company]—the payments volume within [the portfolio company’s] system. Buyers were the most reliable source for that information and Sellers acted reasonably in relying on Buyers’ representations.

The Chancellor also rejected the defendants’ argument concerning the impact lack of a rep in the purchase agreement on the plaintiffs’ ability to rely on its extracontractual representations concerning payment volumes. In doing so, she pointed to the agreement’s absence of an anti-reliance clause:

Buyers also argue that Sellers’ failure to secure a contractual representation regarding Ontario’s payments volume weighs against a finding of reasonable reliance. This argument also fails. Parties to merger transactions can contractually circumscribe exposure to post-closing claims of fraudulent inducement. But Delaware law requires that they do so explicitly through unambiguous antireliance language. Buyers do not dispute that the Purchase Agreement contains no anti-reliance language.

Chancellor McCormick ultimately concluded that the plaintiffs established all the elements of their fraud claim, and awarded them the full amount of the earnout payments set forth in the agreement as damages.

– John Jenkins