Chancery Addresses Viability of Contractual Fraud Claims Allegedly Barred by Agreement’s Terms

Morris James LLP

Online Healthnow, Inc. v. CIP OCL Investments, LLC, C.A. No. 2020-0654-JRS (Del. Ch. Aug. 12, 2021)

Online Healthnow concerns “contractual fraud claims,” meaning a statement made in the agreement itself that is known to be false by the party making the statement and on which the counterparty relies to its detriment. Under a prior Court of Chancery decision in ABRY Partners V, L.P. v. F&W Acquisition LLC, 891 A.2d 1032 (Del. Ch. 2006), a seller cannot contractually eliminate its liability for engaging in knowing contractual fraud through provisions regarding anti-reliance and knowledge, and cannot rely on contractual caps for indemnity to limit the recovery for contractual fraud. This decision addressed the sellers’ unsuccessful attempt to limit the reach of ABRY Partners based on the relevant agreement’s survival clause purporting to terminate the challenged contractual representations at closing and the combination of anti-reliance and non-recourse provisions involving certain defendants.

Online Healthnow involved the acquisition of a continuing education services company. During the sales process, management and board members at the company allegedly were aware of an issue relating to the company’s tax reporting software that had resulted in significant underreporting of sales and use taxes over a period of several years. The sellers, however, did not provide the ultimate buyers with this information during due diligence and made allegedly false representations about the company’s tax liabilities in the agreement. The agreement also included a survival clause terminating all representations and warranties at closing and a non-recourse provision precluding buyers from bring claims against certain entities and individuals. After discovering the undisclosed tax issue post-closing, the buyers brought contractual fraud claims against the sellers and the sellers moved to dismiss. 

In denying the sellers’ motion to dismiss, the Court rejected their argument that the agreement’s survival clause terminated the challenged contractual representations at closing and thus barred a contractual fraud claim based on those representations. Relying on ABRY Partners and Delaware law’s abhorrence of fraud as a matter of public policy, the Court extended the reasoning of ABRY Partners to the facts of this case, holding that the sellers could not “invoke a clause in a contract allegedly procured by fraud to eviscerate a claim that the contract itself is an instrument of fraud.” The Court also rejected the sellers’ argument that certain of the named defendants could not be liable pursuant to the non-recourse provision, explaining that Delaware law “disregard[s] non-recourse clauses where the parties purportedly insulated by those clauses were complicit in contractual fraud.” 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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