Lessons from M&A Battles: Anti-Fraud Disclaimers in Tech Contracts

M&A

Written by Rooney Nimmo Partner, Sean Hogle

In high-stakes transactions in which vast sums of wealth are exchanged in return for ownership in ongoing complex businesses, mergers and acquisitions (M&A) contracts are an oft-overlooked source of clever legal craftsmanship. With so much value and risk embodied in these transactions, counsel for both parties—sought after specialists in these pressure-filled transactions—play a tense game of textual jab and parry, each trying to minimize risk and maximize leverage for their clients. In doing so, they often create compelling contract language readily amenable for use in non-M&A contexts.

Legal acumen and attention in acquisition deals is most likely brought to bear on the representations and warranties, the indemnification provisions, the liability cap, and the fraud disclaimer.

Glenn D. West, a prominent M&A lawyer and commentator whose insights reach well beyond the M&A context, has written extensively about the appropriate contract language to effectively repudiate the threat of fraud claims and avoid liability for extra-contractual statements. He has proven an effective advocate for, among other things, the following propositions:

  • More than a simple “entire agreement” integration clause is required to disclaim reliance on extra-contractual statements effectively.
  • The buyer should be required to disclaim reliance on extra-contractual statements.
  • A simple “except in the case of fraud” disclaimer at the end of an exclusive remedies provision is unacceptably vague and imbued with risk that most practitioners would not accept if they understood the implications.

Beyond M&A, these are worthy guidelines in the licensing and technology transactions context as well. Virtually any transaction in which one side is selling something of significant value (including high-dollar technology licensing or acquisition agreements, IT outsourcing agreements, and enterprise SaaS solution terms) would benefit from the clarity and certainty that comes with limiting the remedies and risks of the parties to the four corners of the contract.

After all, it’s not uncommon for a breach of contract claim to be accompanied by a fraud claim, as a matter of course. As Mr. West ably points out:

Fraud and negligent misrepresentation claims have proven to be hard to define, easy to allege, hard to dismiss on a threshold, pre-discovery motion, challenging to disprove without expensive, lengthy litigation, and highly susceptible to the erroneous conclusions of judges and juries. And ironically, it may be the one alleging the fraud that is the actual ‘fraudster’—not the person against whom the fraud is alleged.

This dynamic is no less applicable in the technology transactions context.

When a big technology implementation project fails, the customer’s lawyers will pretty much always try hard to find opportunities to accuse the vendor of having lied.

Litigation counsel knows that jurors typically won’t un­der­stand whatever tech­nol­o­gy is involved.  (In fact, the customer’s lawyers might well try to exclude any prospective juror who knows even a little about the technology.)

That can make it hard for customers to win such cases on garden-variety ‘technical’ grounds such as breach of contract or warranty. Judges and jurors absolutely do get it, on the other hand, when it appears some­one lied or cheated.

Dell C. “DC” Toedt III, On ContractsWhy the fraud claim is the lawyer’s weapon of choice in lawsuits over failed technology projects (noting that the threat of punitive damages, not available in breach of contract claims but commonly awarded in fraud claims, raises the stakes in this context considerably).

Consequently, technology counsel for both sides should consider the following four drafting points in furtherance of making the written deal the entire deal of the parties.

First, consider establishing the sole remedies for breach of warranties and make such remedies available to the buyer regardless of whether breach involves “intentional, reckless or negligent misrepresentations.” Consider including language such as, “Vendor is not asserting the truth of any warranty set forth in this Agreement; rather the parties intend that if any warranty proves untrue, the Buyer will have the specific rights and remedies set forth in this Agreement and no other.”

Second, consider including disclaimers of reliance on extracontractual statements. Here’s an example: “The parties have voluntarily agreed to define their rights, liabilities and obligations respecting this Agreement and [insert subject matter] exclusively in contract pursuant to the terms of this Agreement, and each party disclaims that it is owed any duties or is entitled to any remedies not set forth in this Agreement.”

Third, for any fraud-related carveouts to the disclaimers, avoid reliance on the all-too-simple “except in the case of fraud.” Fraud can be a great many things, and as such, the term should be defined to avoid ambiguity. One possibility is to define fraud as false statements concerning the express warranties in the agreement. Here’s an example: “Nothing in this Agreement will operate to limit the liability of Vendor to Buyer for fraud in the event Vendor is finally determined to have willfully and knowingly committed fraud against Buyer, with the specific intent to deceive and mislead Buyer, regarding the warranties of section [x].”

From the buyer’s perspective, such measures make the warranties and the express remedies the focal point of the negotiations. The buyer’s counsel will seek to make those warranties and remedies as specific and as concrete as possible, recognizing the value that comes with stable and predictable contract language.

Fourth, both sides are equally served by a robust integration and merger clause and a choice of law and forum clause that captures not just contract claims but tort claims as well (e.g., “This Agreement and all related disputes will be governed by the laws of ___”). In New York, clauses providing for the agreement to be “governed by” and “construed in accordance with” a particular law have been construed as applying only to disputes concerning the agreement itself, and not to all disputes arising out of the relationship; whereas choice of law clauses applying to controversies “arising out of” or “connected to” the contract are construed to include tort or fraud claims.  In California, “governed by” is construed as encompassing all causes of action arising out of or related to the agreement, including tortious breaches of duties arising out of the agreement.

These drafting measures are by no means foolproof. Motivated litigants can always discover new ways of convincing juries to look beyond the contract’s text. Nevertheless, adopting these measures should go a long way towards ensuring that the parties’ written deal is the entire deal.

The team at Rooney Nimmo has deep experience guiding companies of all sizes through the M&A process. If you need help or have any questions, please call us on +1 212 545 8022 or click here to learn more about our capabilities.

Initially published on epic.law.

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