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Disclaimers of Reliance: Use a Covenant, Not a RepresentationMarch 9, 2016
In M&A acquisition agreements, a target company often will negotiate for a disclaimer from the acquirer that all of the target company’s representations and warranties regarding its business are contained in the four corners of the acquisition agreement. Such a disclaimer can prevent the acquirer from prevailing on a fraud claim based on extra-contractual statements made by the target company during the diligence process. However, as the Delaware Court of Chancery noted in FdG Logistics LLC v. A&R Logistics, not all attempts at such a disclaimer are effective.
In FdG Logistics, a private equity firm purchased a trucking company now owned by A&R Logistics Holdings, Inc., through a merger transaction. After the closing of the transaction, the acquirer alleged that the target company engaged in fraudulent conduct by “an extensive series of illegal and improper activities that were concealed from it during pre-merger due diligence.” In response, the representative of the former target company security holders filed a motion to dismiss such claim based on (i) an exclusive representation provision at the end of the target company’s representations disclaiming any representations and warranties other than those contained in the merger agreement and (ii) a standard “entire agreement” integration clause.
In denying the motion to dismiss, the Court of Chancery, citing to Abry Partners v. L.P. v. F & W Acquisition LLC (among other cases), found that the exclusive representation and the “entire agreement” provision did not constitute an affirmative expression by the aggrieved acquirer that it had relied only on the representations and warranties in the acquisition agreement. According to the Court of Chancery in FdG Logistics, an effective disclaimer of extra-contractual statements should be an affirmative expression by the acquirer of (i) specifically what it is relying on when deciding to enter into the acquisition agreement or (ii) that it was not relying on any representations made outside of the acquisition agreement.
In FdG Logistics, the target company’s error was including the disclaimer of extra-contractual statements in the representations and warranties of the target company, which are statements of the target company, not affirmative expressions of the acquirer. Instead of a non-reliance disclaimer in the representations of the target company, often such a disclaimer is included in the representations of the acquirer. However, even more effective than a representation of the acquirer in this context would be a covenant of the acquirer acknowledging no extra-contractual representations and agreeing to disclaiming reliance on any such representations.
As opposed to a representation, which is merely a statement of fact, a covenant is an agreement with, or a promise to, a counterparty. Accordingly, if a non-reliance disclaimer is included in an acquisition agreement as a covenant of the acquirer (as opposed to a representation), the acquirer is agreeing with, and promising to, the counterparty that it is only relying on the representations and warranties contained in the acquisition agreement. As opposed to a representation, including such a disclaimer as a covenant offers the target company more protection that the acquirer, as the Court of Chancery in FdG Logistics put it, is making an “affirmative expression” that it “unambiguously disclaims reliance on” extra-contractual statements.
This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Paul Scrivano, an O'Melveny partner licensed to practice law in California and New York, and Noah Kornblith, an O'Melveny associate licensed to practice law in California, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.
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