Fraud carve out saves buyer in “as-is where-is” in divestiture

Seller manufactures over-the-counter pharmaceutical products. On June 17, 2016, it sold one of its product lines to Buyer. The terms of that sale were memorialized in an asset purchase agreement.

At the time of the sale, there was a class action suit pending in California that related to one of the products in the transferred product line. Under the terms of the asset purchase agreement, Buyer agreed to assume all future liability arising from that matter. After the class action suit resolved, however, Buyer refused to do so. Seller sued Buyer in a Delaware federal district court.

After Seller filed a complaint alleging that Buyer had breached its asset purchase agreement indemnification duties, Buyer responded with several counterclaims. In those counterclaims, Buyer alleged that, prior to the sale, Seller told Buyer that the class action plaintiffs had offered to settle for “a few hundred thousand dollars,” when in fact those plaintiffs had never offered to settle for less than two million dollars. Buyer also alleged that, during negotiations, Seller failed to disclose several hundred thousand dollars in “store allowance fees” charged by one of the customers of the transferred product line (a fee charged by the customer in order to have Seller’s product placed on the customer’s shelves). These two acts, Buyer argued, were deliberate misrepresentations or intentional concealment of the truth, and as such, constituted what in legalese was called actionable torts—specifically, fraud and intentional concealment. Buyer also included a breach of asset purchase agreement counterclaim for Seller’s alleged failure to disclose certain liabilities at closing, in violation of the net working capital purchase price adjustment provision of the asset purchase agreement.

Seller asked the court to dismiss Buyer’s tort-based counterclaims for fraud and intentional concealment. The court refused to do so.

Seller argued that Buyer’s tort claims for fraud and intentional concealment were really breach of asset purchase agreement claims in disguise and were therefore barred by Delaware law.

First, Seller argued that the damages alleged in the fraud and intentional concealment tort claims were duplicative of the damages alleged in the breach of asset purchase agreement claim. The court disagreed. In its breach of asset purchase agreement claim, Buyer alleged that Seller breached the asset purchase agreement by failing to disclose certain outstanding liabilities at closing (some of which happened to be outstanding “store allowance fees” mentioned above), which—because of the net working capital purchase price adjustment provision in that agreement— caused Buyer to overpay Seller by the exact amount of those undisclosed liabilities. The alleged asset purchase agreement damages, then, were the exact amount of those undisclosed liabilities.

In its fraud and intentional concealment tort claims, by contrast, Buyer alleged that Seller, through fraud or intentional concealment, caused Buyer to agree to an inflated overall price for the transferred business. The alleged fraud and intentional concealment tort damages, then, were the exact amount the “true” price was inflated by Seller’s deception. Though all claims rest on Buyer’s dissatisfaction with paying too much for the transferred business, the fraud and intentional concealment tort and breach of asset purchase agreement claims seek to recover separately overpaid amounts.

Second, Seller argued that any duty owed to Buyer by Seller arose solely from the asset purchase agreement. The court again disagreed, stating that Delaware law itself imposed a duty on Seller to not commit fraud or intentionally conceal material liabilities in a transaction.

Next, Seller argued that the fraud and intentional concealment claims were barred by provisions in the asset purchase agreement that stated (1) that the purchased product line was transferred “as-is where-is”; (2) that Seller made no representations or warranties about the product line; and (3) that all other representations or warranties were expressly disclaimed.  The court rejected this argument because the asset purchase agreement explicitly reserved Buyer’s rights in the case of fraud.

Finally, Seller argued that Buyer’s fraud and intentional concealment tort claims were barred by the economic loss doctrine. The court rejected this argument also. Generally, the economic loss doctrine would limit Buyer’s economic damages to Seller’s alleged breach of the asset purchase agreement’s net working capital purchase price adjustment provision. While this doctrine does generally limit Buyer’s ability to recover in a fraud and intentional concealment tort (which is not based upon the asset purchase agreement) to losses accompanied by bodily harm or property damages and prohibits recovery for losses that are solely economic in nature, there are certain exceptions to this doctrine, including for claims of fraudulent inducement and intentional concealment.

This case is referred to Perrigo Company v. International Vitamin Company, No. 1:17-CV-01778., United States District Court, D. Delaware, (January 28, 2019).

Comment. A seller often wants a buyer to agree that the buyer will only sue the seller for breach of representations and warranties made in the purchase or merger agreement; not misrepresentations made by the seller during negotiations or in information supplied in the seller’s data room. A buyer will often agree to this but with an exception for the buyer’s fraud.

This kind of language all sounds like useless boilerplate, but it can be important to a buyer in circumstances like the deal Buyer found itself in.

By John McCauley: I help people start, grow, buy and sell their businesses.

Email: jmccauley@mk-law.com

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

Telephone:      714 273-6291

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