Delaware Supreme Court Upholds Limitation of Liability Under Nondisclosure Agreements in M&A Deals

The Delaware Supreme Court recently held that non-reliance and waiver provisions in a nondisclosure agreement that the parties sign before a buyer can engage in due diligence for a potential acquisition of the seller’s business are enforceable. The Court also held that the seller’s fraudulent conduct does not adversely affect enforceability.

Factual Background

In RAA Management, LLC v. Savage Sports Holdings, Inc., No. 577, 2011 (Del. May 18, 2012), the plaintiff, RAA Management, LLC (“RAA”), and defendant, Savage Sports Holdings, Inc. (“Savage”), entered into a nondisclosure agreement (“NDA”) under which Savage would provide RAA with confidential information in anticipation of RAA’s acquisition of Savage. The NDA included two customary provisions. First, Savage was not making any representations with respect to the information provided, and was not liable for providing the information. Second, RAA waived any rights in connection with the transaction until the parties entered into a definitive purchase agreement.

RAA then engaged in preliminary due diligence. After a letter of intent was signed, RAA undertook more thorough due diligence. Several months later, RAA became aware of three major liabilities, each of which by itself was sufficient for RAA to abandon the transaction. Finally, RAA notified Savage that it was no longer interested in acquiring Savage, and demanded payment of $1.2 million in “sunken due diligence costs.” RAA contended that Savage made intentional and fraudulent misrepresentations regarding the liabilities at the beginning and during the course of the due diligence. The Delaware Superior Court dismissed RAA’s complaint, and RAA appealed the dismissal.

The Supreme Court’s Opinion

Accepting RAA’s allegations as true, the Delaware Supreme Court affirmed the Superior Court’s dismissal of RAA’s complaint.

RAA’s arguments, among others, were that the non-reliance and waiver provisions did not apply to “willful falsehoods” and Savage’s fraudulent conduct, and that for public policy reasons the NDA should not be enforced in the case of fraud. The Supreme Court rejected these arguments.

First, the Court found that the language in the NDA was unambiguous and applied to any kind of misrepresentation by the seller, whether based on negligence, mistake, fraud, or intentional conduct. It was clear that no liability should exist until a definitive purchase agreement was signed. Because the language of the NDA was unambiguous, there was no room for the interpretation put forward by RAA.

Second, the Court rejected RAA’s public policy argument. It reasoned that allowing RAA to prevail would disregard RAA’s promise not to rely on any information provided in the due diligence process, and not to raise any claims based on misrepresentations made before signing a definitive purchase agreement. To allow RAA to prevail on its claim would “sanction its own fraudulent conduct.”

Lessons Learned

Assuming that courts in other jurisdictions will follow RAA Management, buyers should take away from this decision that any costs incurred in connection with M&A due diligence on a transaction abandoned before signing a definitive purchase agreement are not recoverable. If buyers want to be protected against this risk, they will have to negotiate specific exceptions to the nonreliance and waiver provisions customarily found in NDAs, such as an exception for fraud. For instance, definitive M&A purchase agreements often have a fraud exception to the limitations on indemnification rights, such as caps, thresholds or survival periods. However, consistent with past practice and absent significant leverage for the buyer, sellers are unlikely to agree to exceptions in NDAs.

This alert was written by Peter Flägel, a Director in the firm’s Corporate Department. For more information on this topic, please contact him, or Frank T. Cannone, Brian DiBenedetto, Robert F. Coyne, Cheryl A. Gorman, Terry Myers or Steven H. Sholk.