APA Integration Provision and Exclusive Remedy Clause Bars Seller Claim

Introduction

A seller of a mortgage service business could not sue its asset buyer in tort for negligent misrepresentation.

The deal

The seller was a Denver based company that was formed after the 2008 financial crisis to assess and verify loan data for large banks, institutional investors, hedge funds, loan-servicing companies and other financial institutions involved in mortgage lending or investing.

The buyer is part of a 120 year old Houston based company group which includes one of the largest title companies in the U.S.

The buyer purchased most of seller’s assets in August of 2013 for $15 million in cash payable at closing and an earnout based upon the 3 year post closing performance of the business.

The lawsuit

The seller’s business struggled before the closing; partly because private label mortgage securitization had not come back after the financial crisis and due to a lawsuit brought by a large bank customer of seller for seller’s alleged breach of conflict of interest contractual representations.

This downward trend in the mortgage securitization business continued after the closing, along with the decline of financial crisis mortgage foreclosure business. Furthermore, the purchased business suffered from the loss of other major customers due to reputational damage resulting from the judgment obtained against the seller after the closing from the large bank customer lawsuit; along with other pre-closing seller behavior.

As a result, the earnout targets were not met; earnouts were not paid; and the buyer closed the business.

The seller filed for bankruptcy protection in Delaware after the large bank customer judgment and the seller sued the buyer. One of the seller’s claims was in tort for negligent misrepresentation. The seller claimed that the buyer misrepresented that it would invest in the business after the closing and was able to run the business as it had been run by seller when instead buyer stripped financial and human resources from the business and failed to provide adequate leadership; that the buyer had resources in Costa Rica that could be used to the business’s benefit when those resources would not be available until 2015; that seller’s founder would remain an important part of the business, when buyer marginalized her involvement immediately and fired her without cause in January 2014, barely five months into the first year of the earnout; and that the buyer would take steps to retain key employees, including paying retention bonuses, when it failed to retain numerous key employees, many of whom left to join competitors of Seller.

The seller claimed that if the buyer had told the truth, the seller would not have entered into the APA and would have retained its valuable assets and the business for investment in or sale to another purchaser. According to the seller, the value of such assets and the business was $42 million at closing. Accordingly, Seller claimed tort damages for its negligent misrepresentation claim of $27 million, which is the $42 million valuation minus the $15 million in consideration already paid.

The court found no misrepresentations in fact. Furthermore, more fundamentally, the court concluded that the seller could not bring a negligent misrepresentation claim in tort against the buyer as a matter of law for several reasons.

A. Under the APA’s Colorado choice of law provision, the APA integration clause preempts any duties the buyer owes to the seller other than the duties and remedies provided for in the APA: “In other words, the parties specifically contracted away tort liability, including negligent misrepresentation claims. “

B. The APA’s indemnity provision also bars the seller’s negligent misrepresentation claim. The indemnity provision was the “sole and exclusive remedy” for breach of any representation “relating to the subject matter” of the APA. Except for claims based on intentional fraud, the seller had no other remedy and waived all other causes of action for “any breach of any representation set forth herein the Agreement (or otherwise relating to the subject matter of the Agreement).

C. A negligent misrepresentation claim cannot be based on a promise to do something in the future. It must be based on a misrepresentation of a “material past or present fact.”

D. The economic loss rule further restricts the seller’s negligent misrepresentation claim. The economic loss rule states that Seller, who suffers only economic loss from the Buyer’s breach of an express or implied APA duty may not assert a tort claim for such a buyer breach absent an independent duty of care under tort law; and the seller did not asset any independent buyer duty of care owed the seller.

This case is referred to In Re Allonhill, LLC.Case No. 14-10663 (KG), Adv. Pro. No. 16-50419 (KG), United States Bankruptcy Court, D. Delaware, (Filed April 25, 2019)

Comment

Why would a seller in an M&A deal gone bad sue the buyer in tort for negligent misrepresentation? Several common reasons.

Often the right to sue for breach of the APA or other M&A agreement may be capped at a number less than the loss suffered by the seller.

Another reason is that the buyer did not breach the M&A agreement. Nevertheless, the buyer could have made material misrepresentations or omissions in the virtual data room, in other due diligence or in negotiations. In those cases, the claim is not for breach of the M&A document but for fraud or misrepresentation based upon tort, not contract law

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million).

Email:             jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291

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Posted in earn out, economic loss doctrine, exclusive remedy, integration clause Tagged with: , ,

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