Court of Chancery Dismisses Fraud Claim for Alleged Extra-Contractual Misrepresentations Based on Anti-Reliance Clause

Aug 31 2018

In ChyronHego Corporation, et al., v. Cliff Wight and CFX Holdings, Inc., C.A. No. 2017-0548-SG (Del. Ch. July 31, 2018), the Delaware Court of Chancery granted the defendants’ motion to dismiss the plaintiffs’ claim for extra-contractual fraud on the basis that the stock purchase agreement contained an effective anti-reliance clause that precluded such claim. The Court found that the anti-reliance clause rebutted the common law fraud element of reliance on any extra-contractual representations, as described further below. At the same time, the Court dismissed the defendants’ motion to dismiss claims for fraud and breaches of express representations and warranties under the stock purchase agreement, finding that the plaintiffs had sufficiently pleaded the elements of these claims.

In July 2016, ChyronHego Corporation (“ChyronHego”), the buyer, entered into a stock purchase agreement regarding the purchase of Sound & Video Creations, LLC (d/b/a Click Effects) (the “Company”) for approximately $12.5 million in cash and equity, with CFX Holdings, Inc. (“CFX”) and the other selling stockholders of the Company. Prior to the acquisition, Cliff Wight (“Wight”), the owner and president of the Company, and the Company provided due diligence materials to the buyer in a transaction data room, and also separately provided requested financial information in connection with a quality of earnings report prepared by ChyronHego and its advisors.

In the year following the acquisition, the Company performed poorly, substantially failing to meet several projections. ChyronHego and its parent holding companies (“Plaintiffs”) alleged that Wight and CFX (“Defendants”) committed fraud and breached the stock purchase agreement with ChyronHego by fraudulently misrepresenting the actual financial condition and value of the Company. Specifically, Plaintiffs allege Defendants disclosed misleading documents and projections in the transaction data room, provided misleading information in connection with the preparation of the quality of earnings report, and knowingly made false representations in the stock purchase agreement. Plaintiffs allege that Wight intentionally manipulated sales data to artificially inflate the book value of the Company, in particular “maneuvering” invoices to “smooth earnings” by changing the dates of outstanding invoices and invoicing open orders early instead of upon shipment, which Plaintiffs allege was a deviation from the ordinary course of business. Plaintiffs also alleged that Wight was aware of changes in customer demand and general adverse business conditions that should have been disclosed and allegedly breached several representations in the stock purchase agreement, and had failed to provide a “true, correct and complete copy” of a lease agreement between the Company and Wight, which was intentionally produced and misleadingly backdated as part of the acquisition. Finally, Plaintiffs made various indemnification claims under the stock purchase agreement based on these alleged facts, including that Defendants made material misrepresentations about GAAP compliance as consistently applied.

On July 27, 2017, Plaintiffs filed suit, and Defendants moved to dismiss the complaint under Rule 12(b)(6) for failure to state a claim upon which relief may be granted. When reviewing a motion to dismiss, the Court must accept all well-pled factual allegations as true and draw all reasonable inferences in favor of the non-movant (here, Plaintiffs).

On review, the Court determined that the stock purchase agreement contained an explicit anti-reliance clause by ChyronHego disclaiming buyer’s reliance on extra-contractual representations, which dictates what representations (or misrepresentations) may form the basis for a fraud claim. The anti-reliance clause stated that the buyer agreed that the Company and the selling stockholders made no representations or warranties other than those contained in the stock purchase agreement, including with respect to any financial projections or budgets, and contained a carve-out that such provision would “not preclude [buyer] from asserting claims for Fraud.”[1] Interestingly, the Court describes the definition of “Fraud” under the stock purchase agreement as “meaning fraud as defined by common law and determined by a court of competent jurisdiction” and the Court does not indicate that “Fraud” (as so defined) was limited in any way to the representations or warranties contained in the agreement. The Court also examined the exclusive remedies provision, the integration provision, and the fact that “Fraud” was excluded from the limitations and procedures applicable to claims under the indemnification provision, and found none of those provisions operated to preserve a right by buyer to sue for fraud based on extra-contractual statements.

With respect to Plaintiffs’ remaining claims at issue, the Court determined that Plaintiffs had alleged sufficient facts that made it reasonably conceivable that the representations allegedly given by Defendants were knowingly false when made, and that Defendants may have committed fraud and breached the specific representations, warranties, and covenants under the stock purchase agreement. The Court denied Defendants’ motion to dismiss such Plaintiffs’ claims on that basis.

Finally, the Court disagreed with Defendants’ argument that Plaintiffs’ fraud claim against CFX failed as a matter of law because CFX did not make any of the representations and warranties at issue. Instead, the Court held that “a selling stockholder may face liability for representations made by the company if the stockholder either (i) knew that the company’s representations were false or (ii) lied to the buyer about those representations.” Because Wight, as owner and president of the Company, allegedly knew the Company’s representations were false or misleading, and because he was the sole principal of CFX, the Court found that his knowledge was imputed to CFX. Further, the Court notes that CFX and the other selling stockholders agreed to “jointly and severally” indemnify the buyers for the Company’s obligations under the stock purchase agreement.

[1] The anti-reliance clause, contained in Section 4.7 of the stock purchase agreement, is quoted in full below:

Holdings and the Buyer agree that neither the Company, any Seller nor any of their respective Affiliates or advisors have made and shall not be deemed to have made any representation, warranty, covenant or agreement, express or implied, with respect to the Company, its business or the transactions contemplated by this Agreement, other than those representations, warranties, covenants and agreements explicitly set forth in this Agreement. Without limiting the generality of the foregoing, the Buyer agrees that no representation or warranty, express or implied, is made with respect to any financial projections or budgets; provided, however, that this Section 4.7 shall not preclude the Buyer Indemnified Parties from asserting claims for Fraud or indemnification in accordance with ARTICLE VII.

ChyronHego Corporation, et al., v. Cliff Wight and CFX Holdings, Inc., memorandum opinion 180731