Fraud Based Upon Oral Future Promises (Unlike Fraud Based Upon Oral Misrepresentations of Fact) Can Be Defeated by a Standard Integration Clause

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Fraud claims premised upon oral statements made during the negotiation of an acquisition agreement can take a variety of forms. Sometimes the extra-contractual statements that are the basis of a fraud claim are not alleged to have been traditional misrepresentations of fact by a party, but instead are alleged to constitute misrepresentations by a party of that party’s future intent (so-called “promissory fraud”). And the alleged fraudsters in these claims are not always the sellers; sometimes sellers sue buyers for fraud too. The typical circumstances in which sellers sue buyers for fraud are those involving earnouts—i.e., contractual arrangements requiring additional purchase price to be paid for a business when the purchased business meets agreed-upon performance targets that the seller was convinced the business would achieve, but the buyer was unwilling to pay for in advance of the business actually achieving those targets. A recent Delaware Court of Chancery decision, Shareholder Representative Services LLC v. Albertsons Companies, Inc., 2021 WL 2311455 (Del. Ch. June 7, 2021), involved just such a fraud claim by the sellers against the buyer when the purchased business failed to meet the agreed-upon performance targets required to trigger an earnout payment.

Earnouts are fraught with potential post-closing litigation risk for a buyer because there are always questions as to whether the buyer operated the purchased business in a manner that maximized the potential to achieve the agreed-upon performance targets. Having purchased the business and taken all downside risk, the buyer certainly does not want to be constrained in how it decides to operate the business post-closing. But the seller also expects that the buyer will not deliberately operate the business in a manner that is designed to ensure the performance targets are not met solely to avoid the payment of the earnout. Bridging these competing concerns of the buyer and seller typically involves carefully negotiated contractual provisions. But sometimes, when the target fails to achieve performance milestones post-closing, allegations of fraud are made by the sellers against the buyers based upon alleged extra-contractual statements made by the buyers during the negotiation of the acquisition.

In Albertsons Companies, the selling shareholders of the target company, DineInFresh, Inc., sued the buyer, Albertsons, for breach of contract and fraud, when the target failed to achieve any of the “earnout milestones.” According to the selling shareholders, the buyer made numerous extra-contractual representations during the negotiation of the acquisition agreement regarding the buyer’s plans to continue to operate the target as an ecommerce business post-closing, rather than integrate the target business into Albertson’s traditional bricks-and-mortar retail grocery business. The selling shareholders alleged that had Albertson’s continued to operate the target business as an ecommerce business, the earnout milestones would have in fact been achieved. The sellers further alleged that the buyer never intended to operate the target post-closing as an ecommerce business as it had allegedly represented, but was instead only interested in what the target’s data science could do to enhance Albertson’s existing bricks-and-mortar grocery business.

But, as is typical, the acquisition agreement expressly provided that the buyer was to have sole and absolute discretion in how it operated the target post-closing; and that it was to have no obligation to operate in a manner that was designed to achieve the earnout milestones. The buyer did agree, however, that it would not “take any action (or omit to take any actions) with the intent of decreasing or avoiding any [payment of the earnout consideration].” According to the selling shareholders, after closing the buyer changed the target’s business model from an ecommerce operation to one focused on Albertson’s existing bricks-and-mortar business; and, as a result, the target failed to achieve any of the earnout milestones.

Although the Court of Chancery determined that the selling shareholders’ claims for breach of contract would survive the buyer’s motion to dismiss the complaint because the selling shareholders had “well-plead that Albertsons knew that pivoting from subscriptions to in-store sales would be unsuccessful in the short-term such that [the target company] would miss the Earnout milestones[,]” it dismissed the selling shareholders’ fraud claims; and it did so despite the fact that there was apparently no anti-reliance provision in favor of the buyer in the acquisition agreement. Instead, there was only a standard integration clause, which as everyone knows is generally not sufficient to bar fraud claims based upon alleged oral misrepresentations of fact. Thus, had the selling shareholder alleged that the buyer had made extra-contractual statements of fact, the integration clause presumably would have been ineffective in defeating that claim.

The selling shareholders were not alleging that the buyer made any misrepresentations of fact, however, but instead alleged that the buyer had “lied” about the buyer’s future intent respecting the operation of the target post-closing. According to the Court of Chancery, “[w]hile anti-reliance language is needed to stand as a contractual bar to an extra-contractual fraud claim based on factual misrepresentations, an integration clause alone is sufficient to bar a fraud claim based on expressions of future intent or future promises.” Indeed, “[a]s distinguished from a claim of extra-contractual fraud based on a statement of fact, the fraud claim based on a ‘future promise’ amounts to an improper attempt to introduce ‘parol evidence that would vary the extant terms in the subsequent integrated writing.’” As a result, the selling shareholders are free to attempt to prove a breach of the specific contractual commitment made by the buyer not to intentionally take action to avoid the payment of the earnout, “but [they] cannot claim fraud based on future promises [to continue to operate the target as an ecommerce business] not memorialized in the Merger Agreement.”

Obviously this distinction between claims of fraud based on misrepresentations of fact and future promises (so-called “promissory fraud,” which is a real thing and one of the many varieties of fraud potentially captured by an undefined fraud carve out[1]) is equally applicable whether the alleged fraudster is the seller or the buyer. And this holding is consistent with other cases that hold that reliance on extra-contractual statements are in general not justified (even in the absence of a non-reliance clause) when the written contract directly contradicts the alleged extra-contractual statement.[2]

Endnotes

  1. See Glenn D. West, That Pesky Little Thing Called Fraud: An Examination of Buyers’ Insistence Upon (and Sellers’ Too Ready Acceptance of) Undefined “Fraud Carve-Outs” in Acquisition Agreements, 69 Bus. Law. 1049, 1061-1063 (2014).
  2. See Glenn West, There is No Fraud Without “Justifiable” Reliance: Unambiguous Terms of Written Contract Trump Claims of Fraudulent Inducement Even in the Absence of an Effective Non-Reliance Clause, Weil Insights, Weil’s Global Private Equity Watch, March 7, 2019, available here.

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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