Delaware Chancery Court Declines to Dismiss Fraud Claims Against Private Equity Fund and Directors
In Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, the Delaware Court of Chancery denied the defendants’ motion to dismiss fraud-based claims made in connection with Great Hill’s acquisition of Plimus, a private company, from SIG and Plimus’ founders.
In 2011, Great Hill acquired Plimus from SIG and Plimus’ other stockholders pursuant to a merger agreement that contained an exclusive remedy provision limiting Great Hill’s remedies for a breach of contract to the indemnification provisions in the merger agreement, except in the event of fraud. Prior to the acquisition, one of Plimus’ two key vendors had terminated its contractual relationship with Plimus following allegations by the vendor that Plimus had breached material contractual obligations and failed to comply with applicable law in performing its obligations under the contract. While Great Hill was aware of the termination of the contract prior to the acquisition, it alleged that Plimus’ management team had represented that Plimus had terminated the contract in order to pursue a different relationship that better suited its interests. Plimus’ other key vendor terminated its contract with Plimus eight days after the acquisition, alleging similar non-compliant activity by Plimus.
Great Hill alleged that Plimus’ management team actively concealed the pending terminations of Plimus’ key vendor relationships, including the vendors’ allegations of breach and non-compliance by Plimus, and misrepresented the status of its key vendor relationships to Great Hill. Great Hill further alleged that SIG and Plimus’ board of directors were aware of Plimus’ issues with its key vendors, directed Plimus’ management team to misrepresent the issues to Great Hill and aided and abetted management’s fraud. In furtherance of its allegations, Great Hill produced numerous internal communications among Plimus’ management team and Plimus’ board of directors, which consisted of Plimus’ chief executive officer, its two founders and two directors appointed by SIG.
In addition, Great Hill argued that, as a result of the fraud, the contractual limitations for indemnification contained in the merger agreement (such as the indemnity cap and deductible, several liability for Plimus’ stockholders and sole recourse for Great Hill’s damages against a third-party escrow) did not apply. The defendants responded that the exclusive remedy provision permitted direct recovery against the perpetrators of the fraud in a tort action, but did not permit unlimited indemnification under the merger agreement.
The court’s decision is noteworthy on several fronts. First, much of the evidence proffered by Great Hill was obtained from Plimus’ email servers and other pre-acquisition records. In a 2013 decision, the court ruled that, because Plimus’ stockholders had not expressly retained pre-closing communications, including communications among the pre-closing directors, and information protected by the attorney-client privilege, Great Hill was entitled to use such information in its complaint. Secondly, the court held that, in order to withstand a motion to dismiss, Great Hill was not required to plead that SIG and the directors knowingly participated in the fraud. Rather, Great Hill was required only to plead facts permitting an inference that the alleged fraud was knowable and that the directors and SIG were in a position to know of the fraud. Although the court did not rule on the indemnification limitation issue, it did suggest that the defendants’ interpretation of the exclusive remedy provision was more commercially reasonable. Accordingly, the decision reminds practitioners that, if parties intend that indemnification limitations not apply to a breach of contract claim resulting from fraud, the acquisition agreement should expressly carve out fraud from those limitations.
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