Delaware Business Litigation Report

Court of Chancery Holds That Exclusive Remedy Provisions Alone Are Not Enough To Bar Fraud Claims Based On Extra-Contractual Statements

Fortis Advisors LLC v. Johnson & Johnson, C.A. No. 2020-0881-LLW(Del. Ch. Dec. 13, 2021)
Delaware public policy respects freedom of contract, but it is also intolerant of fraud. These dueling policy aims are often pitted against one another in the context of complex commercial transactions, where the contracting parties agree to allocate risk – including limitations on the information relied on in entering the transaction. Delaware courts have struck a balance: contractual disclaimers of reliance are permitted, but they must be express and limited to the other party’s extra-contractual statements. Here, the Court of Chancery considered whether an exclusive remedies provision was alone sufficient to disclaim reliance on extra-contractual statements.

Pursuant to a merger agreement, Johnson & Johnson acquired a robotic medical company, Auris Health, Inc., for $3.4 billion, with the Auris’ shareholders also being entitled to additional earnout payments of up to $2.3 billion tied to FDA regulatory milestones. The merger agreement also included an exclusive remedy provision, requiring that all claims arising out of the merger be asserted within a year of closing through the indemnification process outlined therein. The exclusive remedy provision had an express exception for fraud claims based on representations and warranties in the agreement – but not for fraud claims based on extra-contractual statements. When the FDA regulatory milestones were not met and the earnout payments not made, the shareholders’ representative brought suitunder a number of theories, including fraud, rescission based on mutual mistakeand breach of the implied covenant of good faith and fair dealing.

Defendants moved to dismiss. Most relevant here, the Defendants argued that thefraud claim based on alleged extra-contractual statements was barred under the exclusive remedies provision which, according to the Defendants, operated as a disclaimer of reliance on statements made outside of the merger agreement. Relying on case law that disclaimers of reliance on extra-contractual statements must be express, the Court held that the exclusive remedies provision was not thesort of express disclaimer of reliance that is required to bar a fraud claim.

Also of note is the Court’s denial of the Defendants’ motion to dismiss the mutual mistake and implied covenant claims. The merger agreement tied the Auris’ shareholders’ right to earnout payments to the completion of a specific FDA regulatory approval program. Subsequently, the FDA changed the regulatory approval process under which Auris’ products would be evaluated. The former stockholders asserted that, based on a mutual mistake, the incorrect FDA milestone had been included in the merger agreement. The implied covenant claim was based on the same theory – the parties would have included a provision for the other FDA process, but could not have reasonably foreseen the change at the time. Based on the change in FDA approval process, the Court found that both claims had been sufficiently pleaded.

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