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When Is a Seller's Word His Bond?

Articles & Publications

June 20, 2018
By: Edward M. McNally

Every transaction to some extent is based on trust. At least a buyer trusts that a seller is not actively trying to defraud him. But, when is that trust reasonable? That question is important because a buyer claiming fraud must, among other facts, show that it was reasonable for him to rely upon the representations he claims misled him. The recent decision in Edinburgh Holdings v. Education Affiliates, Del. Ch. C. A. 2017-0500-JRS (June 6, 2018), illustrates the importance of pleading facts that support a claim of reasonable reliance on a seller’s representations.

Briefly, Edinburgh involved a claim by the buyers of a business that the seller fraudulently represented the business’s future profits. The trial court granted a motion to dismiss the buyers’ claim holding the “buyers were not justified in relying on [the sellers] alleged extra-contractual representations regarding future performance of the business and management capabilities.” Importantly, this result followed even though the sale agreement did not contain an anti-reliance clause.

The result in Edinburgh turned on the fact that the alleged promise of future revenues was contradicted by a highly negotiated earnout clause that showed future revenues were uncertain. While that makes Edinburgh readily distinguishable from any case not involving an earnout, the implications of Edinburgh are worth considering in more detail.

To begin with, courts should be reluctant to permit every dissatisfied buyer of a business to claim years later that he was misled by the seller. After all, every buyer has a responsibility to honor the deal it made. Trying to get out of that agreement by claiming fraud should require the pleading of specific facts that if true warrant relief and the pursuit of litigation that takes up the time of the courts and the expense of defense. But, what exactly are those “specific facts” that show reasonable reliance?

First, reliance on projections of a business’s future performance is always problematic. Projections are not “facts,” but more like opinions that are generally subject to caution. As Edinburgh points out, reliance on projections of future earnings is only actionable when there is proof that the sellers knew of specific facts showing those projections “were unsound from the inception” and that the buyer did not know that was the case.

Delaware Business Court Insider, June 20, 2018

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