As the market enters the 12-to-18-month period since deal activity began to increase after the onset of the pandemic, it is important to revisit potential pitfalls regarding indemnification claims. The Delaware Court of Chancery's decision in Pilot Air Freight, LLC v. Manna Freight Systems, Inc.,1 is a cautionary tale about a common misconception by buyers that simply asserting a timely indemnification claim notice is sufficient to toll the applicable survival period and preserve a future breach of contract lawsuit premised upon breaches of representations and warranties in the agreement. Buyers and sellers need to exercise care in reviewing their agreement's survival and indemnification provisions to consider whether there is an express tolling mechanism that continues to preserve such claims.
Indemnification Claim Notices Do Not Always Preserve Subsequent Lawsuits for Breach of Representations and Warranties. In Pilot Air, the Buyer sought indemnification for alleged breaches of the Seller's representations and warranties. The parties' APA provided that the Seller's representations and warranties survived closing for fifteen months, and then would expire. The Buyer - cognizant of the fifteen-month survival period - timely served an indemnification claim notice upon the Seller. However, on the mistaken belief that simply serving a claim notice was sufficient to toll the survival period for such a claim, the Buyer did not file a lawsuit within that fifteen-month period. The critical question in the subsequent lawsuit was whether the APA contained a provision expressly stating that delivering a claim notice preserved the Buyer's indemnification claim until it was finally resolved by the court, which would allow the Buyer to deliver a timely claim notice and then enjoy a tolling of the survival period with the freedom to file a subsequent lawsuit, if necessary. However, the APA in Pilot Air did not expressly contain such a tolling mechanism and the Buyer filed its lawsuit after the fifteen-month survival period expired. In the absence of express tolling language, and despite the timely claim notice, the Delaware Chancery Court ruled that Pilot Air's claims for breaches of the APA's representations and warranties were time-barred and dismissed the claims in their entirety, dealing a significant blow to a likely-unsuspecting Buyer. Thus,it is not safe to assume that simply delivering a claim notice in accordance with an agreement automatically preserves the ability to file a breach of contract claim later on.
Expired Representations and Warranties May Still Give Rise to a Fraud Claim, But With a More Stringent Standard of Proof. In Pilot Air, the Buyer also asserted a companion fraud claim based on the same representations and warranties, which required a different timeliness analysis. It is common for transaction agreements to contain a fraud "carve-out" provision which provides that fraud claims are exempt from the other indemnification limitations in the agreement. The APA in Pilot Air contained a provision stating that claims of fraud could be brought "at any time" against the Seller without going through the indemnification procedures in the APA. Due to the fraud "carve-out," the Court held that even though the Plaintiff's fraud claim was premised on the same expired representations and warranties as the untimely breach claim, the parties did not intend to limit fraud claims and so Delaware's default three-year statute of limitations applied to the fraud claims. Thus, although the Buyer was still able to assert a fraud claim based on the expired representations and warranties, the Buyer's mistake in not timely filing a lawsuit for breach of contract within the fifteen-month survival period left it with a fraud claim subject to additional bases for dismissal and the more stringent standard of proof.
The Takeaway. If you have a claim for breach of representations and warranties in an M&A agreement, do not assume that delivering a timely indemnification claim notice protects your ability to later file a lawsuit for breach of those same representations and warranties. Parties should consider the specific language in the transaction agreement and negotiate for a tolling mechanism that preserves contract claims based on alleged breaches of representations and warranties. In the absence of a tolling mechanism, parties may be able to assert a fraud claim, but will be subject to the court's higher standards of proof. In sum, it is critical to engage experienced M&A litigation counsel well before the expiration of any survival period to analyze the applicable time limitations on your claim.
Footnote
1 Pilot Air Freight, LLC v. Manna Freight Systems, Inc., 2020 WL 5588671 (Del. Ch. Sept. 18, 2020).
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