From the Supreme Court of Delaware last week comes an important reminder to all private companies that in the context of a merger or acquisition, the ability to protect a seller from post-closing fraud claims is limited.

In ABRY PARTNERS V, L.P. v. F&W Acquisition LLC, decided on February 14, 2006, the Court found that it is against Delaware public policy to allow a seller to avoid rescission or limit damages for a material intentional misrepresentation of fact in a purchase contract, even if the parties have agreed on monetary damages with a capped indemnity as the sole remedy for breaches of representations and warranties.

In reaching its decision, the Court created the following bright-line rule: A seller cannot insulate itself from the possibility that a sale may be rescinded if the buyer can show either

  1. that the seller knew the relevant contractual representations and warranties were false; or

  2. that the seller lied to the buyer about a contractual representation and warranty.

The Court cautioned, however, that this bright-line test does not release a sophisticated buyer from the inherent risk it assumes that a seller may act with recklessness or negligence in drafting its representations and warranties. Instead, the Court underscored the requirement that a buyer must prove a seller's actual knowledge of a misrepresentation made by the seller or another selling party.

In addition, buyers and sellers should also note that the sale agreement in ABRY contained a "non-reliance" clause, in which the buyer disclaimed reliance on facts and representations not expressly written in the agreement. The ABRY ruling treated this as a key fact in concluding that no fraud could be claimed with respect to representations not written into the contract. Accordingly, buyers and sellers should carefully consider the effects of non-reliance clauses in acquisition contracts.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.