Transaction agreements governed by Delaware law often feature two related clauses speaking to the scope of a buyer’s reliance and due diligence. The first, known as an anti-reliance clause, establishes that a buyer is relying only on the seller’s representations made in the four corners of the agreement. The second, related clause (sometimes appearing together with anti-reliance language) establishes that a buyer has conducted its own independent investigation of the business’s condition to the buyer’s satisfaction. Delaware courts have generally interpreted both clauses as protecting a seller and limiting the factual basis of a buyer’s post-acquisition fraud claim.
In Paragon Metals Holdings v. Michael J. Smith, the buyer and seller attempted to expand the effect of anti-reliance and independent investigation clauses beyond their traditional applications to—in the buyer’s case—defeat the seller’s justifiable reliance defense and—in the seller’s case—to impose a reasonable due diligence obligation on the buyer. On appeal from the Delaware Superior Court’s post-trial decision, the Delaware Supreme Court declined to extend the application of anti-reliance and independent investigation clauses to defeat the seller’s justifiable reliance defense or to impose a “reasonable” due diligence obligation on the buyer.
Background and the Court of Chancery’s Decision
The buyer-plaintiff (buyer) purchased seller-defendant's (seller) automative parts business under an equity interest purchase agreement (purchase agreement). Relevant here, Seller represented in the purchase agreement that the business had not suffered a material adverse effect (MAE) and that no customer had or intended to decrease the volume of its orders. In turn, the buyer acknowledged that it had conducted an “independent investigation and verification” of the business’s condition “to the buyer’s satisfaction.” The buyer further acknowledged that it was relying on its independent investigation and verification, as well as the seller’s representations in the purchase agreement. Finally, the buyer disclaimed reliance on representations outside of the purchase agreement—a standard “anti-reliance” clause.
Post-trial, the Delaware Superior Court found that the seller’s representations regarding the MAE and customer volumes were false. According to the Superior Court’s factual findings, the seller was aware (but did not disclose) that two customers intended to reduce the volume of their orders and had entered into amended contracts to that effect. However, the Superior Court also found that the buyer was aware (or should have been aware) of a number of “red flags” pertaining to the reduction in customer volume and, thus, the buyer did not justifiably rely on the seller’s contractual representations.
On appeal, the Delaware Supreme Court considered two arguments regarding the buyer’s justifiable reliance. First, the Supreme Court considered whether an anti-reliance clause works to defeat a seller’s justifiable reliance defense, where the “red flags” are outside of the transaction agreement. Second, the Delaware Supreme Court considered whether the independent investigation clause imposed a reasonable due diligence requirement on the buyer. The Supreme Court rejected both arguments.
As to the anti-reliance clause, the Supreme Court found that its purpose in transaction agreements is not to “protect” buyers. Instead, according to the Supreme Court, the sellers are the “intended beneficiaries” of the anti-reliance clause. Specifically, anti-reliance clauses protect sellers from post-acquisition fraud claims based on representations made outside of the agreement. The Supreme Court declined to apply an anti-reliance clause to establish buyer’s justifiable reliance on “intra-contractual” representations.
Similarly, the Supreme Court found the buyer’s acknowledgment that the buyer had conducted an independent investigation to the buyer’s satisfaction did not create a contractual requirement on the buyer’s part to conduct “reasonable” due diligence. In the Supreme Court’s view, the independent investigation language was part and parcel of disclaiming reliance on extra-contractual representations and did not, separately, create a buyer diligence obligation.
Key Takeaways
Delaware courts view anti-reliance and independent investigation clauses as serving a specific purpose: disclaiming a buyer’s reliance on representations made outside of a transaction agreement. At bottom, the clauses protect sellers. In Paragon Metals, the Delaware Supreme Court declined to extend an anti-reliance and independent investigation clause beyond its traditional application to either establish the buyer’s justifiable reliance on the seller’s intra-contractual representations or to impose a reasonable diligence obligation on the buyer. In short, whether the buyer justifiably relied on the seller’s intra-contractual representations was not determined by the terms of the transaction agreement but, instead, by the facts and circumstances of the underlying case.
Originally published in ALM's Delaware Business Court Insider
