When determining whether to uphold an indemnification provision that carved out an exception for only deliberate fraud, the Delaware Supreme Court recently explained in Express Scripts, Inc. v. Bracket Holding Corp., ___ A.3d ___, 2021 WL 752744, at *1 (Del. Feb. 23, 2021), that “[a] deliberate state of mind is a different kettle of fish than a reckless one.”
United BioSource LLC (“UBC”) is a subsidiary of Express Scripts, Inc. (“ESI”) (collectively “the defendants”). Parthenon Capital Partners, LP (“Parthenon”), a private equity fund, formed Bracket Holding Corp. (“Bracket”), a holding company, to purchase three pharmaceutical research and development businesses (collectively “the Company”) from the defendants.
During due diligence, Parthenon voiced concerns about the high balance of unbilled accounts of one of the Company’s divisions, Scientific Services. The defendants’ vice president reassured Parthenon that the unbilled accounts were no cause for concern because it was industry practice and would not create collection problems upon the execution of the sale.
In July 2013, Bracket and UBC executed a $187 million securities purchase agreement (“SPA”) to memorialize the purchase of the Company. Under the SPA, the Company certified that the financial information supporting the EBITDA and the valuation of its working capital were true and correct. The SPA also provided that Bracket would limit its remedy for breach of the SPA’s representations and warranties to an insurance policy obtained for the purpose of the transaction (“R&W Policy”). The indemnification section of the SPA carved out an exception for claims involving deliberate fraud and fundamental misrepresentations:
NOTWITHSTANDING ANY OTHER PROVISION HEREIN TO THE CONTRARY, EACH OF THE BUYER AND PARENT ACKNOWLEDGES AND AGREES, THAT FROM AND AFTER THE CLOSING, EXCEPT IN THE CASE OF FRAUD, PARENT SHALL NOT HAVE ANY DIRECT OR INDIRECT LIABILITY (DERIVATIVELY OR OTHERWISE) WITH RESPECT TO ANY BREACH OF ANY REPRESENTATION OR WARRANTY (OTHER THAN THE FUNDAMENTAL REPRESENTATIONS) MADE BY PARENT IN THIS AGREEMENT. IN FURTHERANCE OF THE FOREGOING, THE BUYER AND PARENT EACH ACKNOWLEDGES AND AGREES THAT EXCEPT IN THE CASE OF ANY DELIBERANT [sic] FRAUDULENT (I) ACT, (II) STATEMENT, OR (III) OMISSION (1) THE SOLE AND EXCLUSIVE REMEDY OF WITH RESPECT TO ANY BREACH BY PARENT OF ANY REPRESENTATION OR WARRANTY (OTHER THAN THE FUNDAMENTAL REPRESENTATIONS) CONTAINED IN THIS AGREEMENT SHALL BE SATISFIED SOLELY FROM THE R&W INSURANCE POLICY ….
Id. at *4 (emphasis in opinion). Thus, only claims for deliberate fraud could be asserted in court and seek recovery beyond the R&W Policy; Bracket’s recovery for any other breach of the SPA was capped at the R&W Policy limits and relegated to arbitration.
After closing, Bracket realized that the defendants had materially overstated the Company’s working capital and revenue to artificially inflate the purchase price. Bracket asserted claims against the defendants under the R&W Policy for breach of the SPA’s representations and warranties in arbitration. Bracket recovered $13 million—the R&W Policy limits—for the defendants’ breach. In a second, subsequent arbitration proceeding, Bracket asserted claims against the defendants for overstating the Company’s working capital and recovered an additional $504,591 as recompense for Bracket’s overpayment.
Bracket then sued UBC, ESI, and the Company’s vice president in the superior court for fraudulent inducement to purchase the Company. Bracket contended that the defendants misrepresented the Company’s revenue and working capital by inflating the Company’s revenue by millions of dollars and failing to disclose the Company’s working capital was negative $2.7 million.
One of the primary issues before the superior court was whether the court should instruct the jury that it may find the defendants liable for deliberate misrepresentations as provided by the SPA, or for both deliberate and reckless misrepresentations as permitted by Delaware common law. The superior court ultimately disregarded the SPA’s “deliberate fraud” limitation and instructed the jury that it could find for Bracket for either deliberate or reckless fraud. The court reasoned that the SPA did not define “deliberate” and there was no evidence that the parties intended to alter the common law state of mind for fraud through the SPA’s indemnification provision. The jury found for Bracket and awarded more than $82 million.
The Delaware Supreme Court framed this issue on appeal by noting the competing policy interests: on the one hand, the court holds parties responsible for fraudulent conduct and, on the other, the court upholds the parties’ freedom to contract, which can include limiting recovery for fraudulent conduct. Upon review of the indemnification section of the SPA and the representations and warranties of the buyer section, the Court determined that “[a] plain reading of the SPA shows that the parties took great care to distinguish between deliberate fraud and other states of mind and conduct.” Id. at *7. It then rejected each of Bracket’s statutory construction arguments, holding that the SPA’s indemnification provision was clear, unambiguously limited Bracket’s recovery to the R&W Policy, and was consistent with the SPA’s other provisions. The Court thus remanded the case for a new trial.
This holding ultimately bolsters the principle of “freedom to contract” and demonstrates that parties can limit liability for fraud, including certain subsets thereof, by contract. When interpreting indemnification and remedy provisions, courts will interpret and apply the plain meaning of qualifying terms, even when such terms are not defined in the contract. Parties to a securities purchase agreement or virtually any contract should therefore carefully review what claims and forms of recovery they are agreeing to limit. Otherwise, they may be left with a bucket of fish they never anticipated.