Chancery Denies Sellers’ Request for Dismissal, Finding That Fraud Claims Were Timely Filed and Properly Pled
This opinion concerns a buyer’s attempt to plead fraud in connection the acquisition of a business. The Court denied in the main the defendants’ motion to dismiss the fraud claims brought in connection with private equity firm American Infrastructure Partners’ (the “Buyer”) $300 million acquisition of Agspring LLC (the “Company”), which was then almost entirely owned by NGP X US Holdings, LLP (“NGP”), another private equity firm.
The transaction was structured pursuant to the a Membership Interest Purchase and Contribution Agreement (the “MIPCA”) as a purchase of the membership units of a holding company, Agspring Holdco, LLC (“Holdco”), which served as the sole member of the Company. Defendant NGP sold 98% of its units, and two members of senior management, defendants Bradley Clark (“Clark”) and Randall Linville (“Linville”), sold the remaining units. The $300 million purchase price was based in part on a financial model provided to the Buyer that projected the Company’s fiscal year (“FY”) 2016 EBITDA at $33 million. The transaction closed in December 2015. Clark and Linville remained as part of the management team after closing. By FY-end of 2016, the Company’s actual EBITDA was approximately $700,000. Clark and Linville each resigned shortly after the numbers were released.
In April of 2019, Plaintiffs brought suit against NGP, Clark and Linville alleging, among other things, that they had committed fraud by concealing significantly lowered internal EBITDA projections prior to the consummation of the sale. Specifically, Plaintiffs alleged that, prior to the consummation of the sale, Clark and Linville had received internal projections significantly lowering the projected EBITDA of a segment of Agspring’s business. Rather than giving the Buyer the downward revised projections, they furnished the lofty projections showing $33 million in EBITDA.
As a threshold matter, Defendants argued that Plaintiffs’ claims were not timely filed because the transaction closed in December 2015 and the original complaint was filed in April 2019--outside of the three-year statutory period for filing fraud claims. Plaintiffs countered that the period should be tolled until July of 2016, when the Company disclosed the actual EBITDA and Clark and Linville resigned, based on theories of fraudulent concealment and equitable tolling. As to NGP specifically, Defendants argued that even if the statutory period was tolled until July 2016 as suggested by Plaintiffs, the claims against NGP were, nonetheless, untimely because they were not added to the complaint until October of 2019.
The Court found that, as to Clark and Linville, Plaintiffs adequately pled fraudulent concealment by alleging that they made statements “to perpetuate the myth” of the inflated forecast. The Court reasoned that equitable tolling was also applicable because Clark and Linville had enriched themselves by concealing their misconduct and the statute of limitations should not protect them as to that conduct. Therefore, the statutory period was tolled until July of 2016 when Plaintiffs were on inquiry notice of Defendants’ fraudulent conduct.
The Court also rejected Defendants’ argument that the NGP claim was untimely, finding that because the claims against NGP arose out of the same “conduct, transaction, or occurrence” as the claims made in the original complaint, pursuant to Court of Chancery Rule 15 (c) they “related back” to the date of the original complaint. Further, because Plaintiffs had adequately pled that NGP knowingly engaged in a conspiracy with Clark and Linville to make fraudulent misrepresentations, the Court held that the statute of limitations would be tolled as to claims against NGP as well.
Defendants next argued that Plaintiffs had failed to plead their fraud claims with sufficient particularity, and therefore the claims should be dismissed. The Court noted that, as an initial matter, the fraud claims were based solely on express representations made in the MIPCA (and related agreements) and no allegations were made about extra-contractual representations. The Court observed that while the pleading standard for fraud is heightened, when a party sues based on a written representation, it is “relatively easy to plead” fraud because “plaintiff can readily identify who made what representations where and when, because the representations appear in the contract.” Defendants argued that, nonetheless, Plaintiffs failed to adequately allege three of the five elements of a fraud claim: (1) the existence of a false representation, (2) knowledge, and (3) damages.
As to the false representation element, Plaintiffs challenged three representations in the MIPCA: (1) a clause stating that Defendants lacked knowledge of “an event or an existing circumstance” that could result in a breach leading to default on a material contract, (2) the “sufficiency of assets at closing” clause; and (3) the material adverse effect (“MAE”) clause. As to the first challenged representation, the Court rejected Defendants’ contention that Plaintiffs could not point to an event or occurrence that had already happened when the transaction closed that caused the Company to default on its debt obligations months after the closing, finding that Plaintiffs had adequately pled that Defendants were aware of the Company’s sharp financial decline that would render the ability of the Company to service its debt in the future unmanageable. As to the “sufficiency of assets at closing” representation, the Court agreed with Defendants that this representation did not support a fraud claim finding that Plaintiffs misconstrued the provision which was merely intended to warrant that a seller would transfer all of the operating assets to the buyer at closing, not that “the assets of the Company would generate financial returns consistent with the past.”
As to the MAE clause, the Court explained that these ubiquitous clauses were intended as a “backstop protecting the acquiror from the occurrence of unknown events that substantially threaten the overall earnings potential of the target in a durationally-significant manner.” Defendants argued that Plaintiffs were precluded from asserting a fraud claim based on the MAE clause because the Plaintiffs were complaining about internal forecasts, and the clause explicitly disallows consideration of the ability to meet forecasts in determining whether something is a MAE. The Court rejected this argument, finding that the clause itself provided a carve-out to the consideration of the ability to meet forecasts in circumstances where, as here, “the facts or circumstances giving rise to such failure or inability may themselves be deemed to constitute, or to be taken into account in determining whether there had been a [MAE].” The Court found that the Plaintiffs alleged that the Company’s performance in the first part of fiscal year 2016 was so poor that it required a reduction of 47% of the FY16 EBITDA forecast—a “fact or circumstance giving rise” to the inability to meet the forecast provided to the Buyer—and that these allegations were “sufficient to support a reasonable inference of a [MAE] at the pleadings stage.”
The Court next rejected Defendants’ arguments regarding Plaintiffs’ alleged failure to meet the knowledge and damages elements of a fraud claim finding that (1) the knowledge element of a fraud claim was not subject to the 9(b) particularity requirement and Plaintiffs adequately pled that Defendants knew that certain representations were false when made, and (2) Plaintiffs had adequately pled that the Company was worth at least $150 million less than the $300 million that the Buyer paid for it satisfying the damages element of a fraud claim. Thus, the Court denied Defendants’ motion to dismiss Plaintiffs’ fraud claims.Share