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If You Don’t Do Your Due Diligence, Your Fraud Claim Might Fail

Where a business fails to allege that it was denied the opportunity to investigate certain representations or that it could not have learned the true facts about the representations through reasonable due diligence, its claim that it was fraudulently induced into entering into a contract based on those representations will fail.  Value Health Solutions, Inc. v. Pharmaceutical Research Associates, Inc., 2019 NCBC 68 (J. McGuire).  As a result, the induced business cannot maintain a claim for either fraudulent inducement or negligent misrepresentation by merely asserting that it “justifiably relied” on representations when deciding to enter into the contract.

Plaintiff Value Health Solutions, Inc. (“Value Health”) and its founder, Nagarajan Parthasarathy (“Parthasarthy” and together with Value Health, “Plaintiffs”) are developers of clinical trial management software (“CTMS”).  Pharmaceutical Research Associates, Inc. (“PRA”) is one of the world’s leading global contract research organizations (“CRO”), employing thousands of people across the world. Plaintiffs developed a CTMS product called “Solution” which they represented to PRA was suitable for use by large CROs like PRA and others. Plaintiffs claimed that when used, would Solution would significantly save time and money in the clinical trial process. For more than a year, Plaintiffs and PRA negotiated various terms as part of PRA’s potential acquisition of Solution.  Plaintiffs represented that Solution was compatible with PRA’s then-existing system, would save PRA significant money in its own business and would generate millions in fees for PRA if it licensed Solution to other CROs.  PRA requested certain changes and upgrades to Solution (“Product Enhancements”). Shortly thereafter Plaintiffs reported that they had made the Product Enhancements and that the enhancements were working well. In reliance on Plaintiffs’ representations concerning the Product Enhancements, PRA acquired Solution for a deal in excess of $2 million in stock and cash.  After acquiring Solution, PRA learned that Solution would be unable to perform the way Plaintiffs had represented, that it was not fully compatible with its present system and that that Plaintiffs had not actually performed the Product Enhancements that PRA had requested.  Plaintiffs filed suit against PRA, and PRA filed a counterclaim against Plaintiffs asserting, inter alia, claims for fraudulent inducement and negligent misrepresentation concerning the Product Enhancements.  Plaintiffs filed a motion to dismiss, contending that PRA had failed to sufficiently plead that it had reasonably relied upon Plaintiffs’ representations.

The Business Court agreed.  Notwithstanding PRA’s general allegation that it had “justifiably relied upon” Plaintiffs’ representations about the Product Enhancements, the Business Court held that such an allegation was merely a “conclusory legal assertion” and that North Carolina law required factual allegations to support the assertion.  Holding that in order to maintain a fraudulent inducement claim PRA was required to have pled facts that showed either that it was denied an opportunity to determine the truth about the representations or that it could not have learned the truth by exercise of reasonable diligence  (Opinion, ¶51),  the Business Court found that PRA’s counterclaim failed to allege facts to support either element. The Business Court noted that PRA failed to allege that it had undertaken any due diligence concerning the representations at any time. Based upon these shortcomings, the Business Court dismissed PRA’s claims for fraudulent inducement and negligent misrepresentation.

Based upon this decision, a business would be well-served to conduct due diligence to test the veracity of any representation that it will rely upon in deciding to enter into a contract; otherwise, the business must be prepared to provide sufficient factual basis to explain why such diligence would have been in vain.   

Additional legal points from this decision:

  • Where a contract is governed by Delaware law, a contract’s merger clause will preclude a claim for fraudulent inducement or negligent misrepresentation only where the clause contains specific, anti-reliance language related to that particular misrepresentation.  (Opinion, ¶¶41-42).
  • In order to maintain a contractual claim for breach of a representation or warranty under Delaware law, the particular representation or warranty must be included within the terms of the agreement itself; representations and warranties extraneous to or leading up to the terms of the agreement are irrelevant to the analysis. (Opinion, ¶¶30-33)
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About this Author

Phil Mohr Bankruptcy and Litigation Attorney Womble Bond Dickinson
Partner

Phil is a trial lawyer. Although he will search for creative legal and business solutions for his clients, his more than two decades of trial experience for both publicly traded and privately held companies in state and federal courts throughout the country have taught him that some cases simply have to be tried to verdict. Representing companies that have both been wronged and accused of wrongdoing, Phil has honed his trial skills in cases involving complex business litigation (including fraudulent transfer and equitable subordination cases in federal bankruptcy court)...

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