Seller of company can sue Buyer for making oral fraudulent and negligent misrepresentations

Seller’s Owner founded Seller in 2002. Seller was based out of the greater Sacramento, California area. In 2007, Seller began doing business as BenefitsCONNECT. BenefitsCONNECT is an online benefits enrollment and administration system that connects employer groups, insurance carriers, third party administrators, payroll vendors, and brokers. In addition to managing BenefitsCONNECT, Seller’s Owner was working on a new venture named Aurora, which would function as an employee benefits agency. In 2015, Seller’s Owner entered into a licensing agreement with BenefitsCONNECT that would give Aurora the right to use the BenefitsCONNECT source code on its own platform, once that platform became operational.

In 2016, Seller and Buyer began negotiating a potential sale of BenefitsCONNECT to Buyer. Buyer is a cloud-based platform for employee benefits and health exchange services, based out of the Chicago area.

During negotiations and due diligence, Seller’s Owner worked closely with Buyer’s CEO regarding the transaction. An asset purchase agreement was executed on August 4, 2016 between Seller and Seller’s Owner, and Buyer. Per the asset purchase agreement, Seller agreed to sell all assets of BenefitsCONNECT to Buyer, including all intellectual property and source coding.

Buyer’s Private Equity Firm financed the acquisition for Buyer and participated in the negotiation of the deal.

On the same day the parties entered into the asset purchase agreement, and per Buyer’ request, Seller’s Owner terminated the Aurora licensing agreement between Seller’s Owner and BenefitsCONNECT.

On May 21, 2018, Seller and Seller’s owner sued Buyer in a Delaware federal court for, among other claims, alleged fraud and negligent misrepresentation against Buyer. Seller/Seller’s Owner alleged Buyer’s CEO misrepresented via an oral promise that Buyer would license the source code to Seller’s Owner for use in the Aurora venture after the sale of BenefitsCONNECT to Buyer. Approximately three weeks after the asset purchase agreement was executed, Seller/Seller’s Owner contended Buyer’s CEO informed Seller’s Owner that Buyer’s CEO had changed his mind and Buyer would not execute a renewed Aurora licensing agreement with Seller’s Owner. Seller/Seller’s Owner alleged that their reliance on this oral promise resulted in their agreement to a lower sale price and the termination of the Aurora licensing agreement between Seller’s Owner and BenefitsCONNECT.

Buyer asked the court to dismiss these claims because of the asset purchase agreement’s integration clause; which essentially says that the only promises made by Buyer in this deal were contained only in the asset purchase agreement. The asset purchase agreement did not contain the Buyer’s CEO’s promise to license back the source code to Seller’s Owner for use in the Aurora venture.

Buyer alleged that Seller/Seller’s Owner cannot maintain a fraud claim because as parties to the asset purchase agreement represented by counsel, Seller/Seller’s Owner could not have reasonably relied on any oral promises that were not memorialized in the heavily negotiated asset purchase agreement. Buyer pointed to the integration clause and other language in the asset purchase agreement to show that Buyer and Seller/Seller’s Owner expressly agreed that the asset purchase agreement contained all of the terms of the sale of BenefitsCONNECT to Buyer, and such terms could only be modified in a writing, signed by both Buyer and Seller/Seller’s Owner.

The court did not agree. The court said that integration clauses may not prohibit Seller/Seller’s Owner’s reasonable reliance on a fraudulent misrepresentation. Whether Seller/Seller’s Owner’s reliance on the oral statement was reasonable given the integration clause of the asset purchase agreement is a question of fact that is generally not suitable for resolution on a motion to dismiss.

Here, Seller/Seller’s Owner provided enough facts for an inference that Buyer’s CEO had motivation to make the statements alleged in order to gain an advantage in negotiation of the asset purchase agreement. Further, since Buyer’s CEO alone made the statements about the source code both before and after the execution of the asset purchase agreement, the facts lie more within the knowledge of Buyer.

Buyer also asked the court to dismiss Seller/Seller’s Owner’s negligent misrepresentation claim. It is based upon the same oral promise. The big difference about this claim is that Seller/Seller’s Owner did not have to prove that Buyer knew the oral promise was false when made; all Seller/Seller’s Owner had to prove is that Buyer did not use reasonable care when Buyer made the oral statement.

The court refused to dismiss the negligent misrepresentation claim. It first said that the integration clause did not bar the negligent misrepresentation claim, any more than it barred the fraud claim.

Nevertheless, Buyer also argued that it had no duty to Seller/Seller’s Owner to be careful when making this oral promise. The court disagreed saying that Delaware law imposed a duty of disclosure on Buyer when Buyer and Seller/Seller’s Owner were in the midst of a business relationship from which Buyer and Seller/Seller’s Owner expect to derive pecuniary benefits. Buyer had a duty under Delaware law to provide accurate information.

Here, the court said that Seller/Seller’s Owner alleged reliance on information Seller/Seller’s Owner received during negotiation of a transaction from which Seller/Seller’s Owner expected to benefit financially, and the information allegedly changed abruptly after the asset purchase agreement was executed, when Buyer’s CEO purportedly changed his mind.

This case is referred to Underwood v. BENEFIT EXPRESS SERVICES, LLC, C.A. No. 18-347-RGA-MPT, United States District Court, D. Delaware, (December 28, 2018).

Comment. Putting the promise to license back the source code to Seller’s Owner in the asset purchase agreement would have substantially reduced the risk of Buyer not following through with its promise.

Seller/Seller’s Owner had also sued Buyer’s Private Equity Firm for aiding and abetting in Buyer’s CEO’s alleged promise to Seller/Seller’s Owner to license back the source code to Seller’s Owner after the closing. However, the fact that Buyer’s Private Equity Firm financed and helped negotiate the transaction was not enough facts to connect it with Buyer’s alleged fraudulent/negligent misrepresentation; and so, this claim was dismissed by the court.

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

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in asset purchase agreement, boilerplate provisions, fraud in business sale, integration clause, no oral modifications of contract, private equity

Recent Comments

Categories