Publications: Can You Rely On That Information? Detailed Representations and ‘Non-Reliance' Provisions in Acquisition Agreements

They are designed to specify the information upon which the parties are relying in deciding to proceed with the transaction. Typically also buried in the boilerplate at the end of such agreements is a “non-reliance” provision, which provides that the buyer (or seller) disclaims any reliance on any information other than that specified in the representations and warranties of the acquisition agreement. For example: “As between or among the parties, any oral or written representation, agreement or statement not expressly incorporated herein, whether given prior to or on the effective date, shall be of no force and effect unless and until made in writing and signed by the parties on or after the effective date.” The exclusion or inclusion of such language and the jurisdiction of the court applying it can have a substantive impact on the success (or failure) of your claims in the event of a dispute arising from the acquisition.

Why should you care?

This issue will typically arise under a claim from the buyer that the seller or its agent provided misleading information regarding the business’ operations or prospects either as part of a pre-sale auction, during due diligence or in the acquisition agreement itself. These will be part of contract or common law claims based on breach of warranty, fraud or negligent misrepresentation. In a stock transaction, an unhappy buyer may also often try to bring securities fraud claims against the seller.

Specifically, federal anti-fraud provisions of the federal securities laws, including Rule 10b-5 of the Exchange Act, which can apply to a stock transaction even if it involves the sale of stock of a privately-held company. Rule 10b-5 requires plaintiffs to demonstrate that the defendant made an intentional misstatement or omission of material fact, upon which the plaintiffbuyer reasonably relied, causing the plaintiff’s injury. A Rule 10b-5 claim, if available, is often the weapon of choice for plaintiffs for two reasons. First, under federal securities law, the exclusive remedy provisions often agreed to in acquisition agreements do not apply to Rule 10b-5 claims. Second, the remedies available under Rule 10b-5 can include not only damages, but rescission of the agreement (including the return of the purchase price). For these reasons, a passable Rule 10b-5 claim can be a source of significant leverage in settlement negotiations.

Incorporation of a “non-reliance” provision is intended to undermine the reasonable reliance element of a plaintiff’s Rule 10b-5 or misrepresentation claim by limiting the scope of information that the plaintiff can rely on.

But does it work?

The Federal Circuit Courts are split on the effect of non-reliance provisions. The Second and Seventh Circuit Courts of Appeals, covering New York and Illinois, respectively, have gone in one direction, while the Third and First Circuit Courts of Appeals, covering Delaware and Massachusetts, respectively, have gone in another. The Supreme Court denied a petition for writ of certiorari on an appeal from the Third Circuit in December 2003. In Harsco Corp. v. Segui (2nd Cir. 1996) and Rissman v. Rissman (7th Cir. 2000), the courts affirmed the effectiveness of “non-reliance” provisions, holding that when combined with detailed representations and warranties, such provisions preclude fraud claims that are based on statements not specifically covered by the representations and warranties. The “non-reliance” provision is used to undermine the buyer’s argument of reasonable reliance on the seller’s extracontractual statements, which is a required element of a claim for fraud or misrepresentation under state and federal securities laws. Under these cases, while a buyer is not entirely precluded from making a claim for fraud, the non-reliance provision limits the range of information on which the buyer can rely on making the decision to proceed with the acquisition.

In contrast, the courts in AES Corp. v. The Dow Chemical Company (3rd Cir. 2003) and Rogen v. Illikon Corp. (1st Cir. 1966) have held in suits brought under Rule 10b-5 of the Exchange Act, that enforcing non-reliance provisions as a bar to fraud claims would be inconsistent with other provisions of the Exchange Act. Specifically, the Act precludes contracting parties from defining the boundaries of their transaction in such a way that relieves a party from the duties imposed by the Exchange Act. These courts have found that even if a party promises not to claim reliance on any representation not set forth in the agreement, such a promise constitutes an impermissible anticipatory waiver of potential fraud claims under the Exchange Act.

Instead, these provisions need to be considered in the totality of the circumstances. The result is that identical claims arising from the same terms and conditions of an acquisition agreement could result in summary judgment for the defendant-seller if New York or Illinois law applies, but a lengthy and far riskier trial if Delaware or Massachusetts law applies.

So what should you do?

When representing a seller, advisors should consider the following:

• Weigh the impact of venue and jurisdiction provisions. If you want to be sure that the Harsco/Rissman rule applies (i.e. that non-reliance provisions preclude fraud claims for extra-contractual statements), consider incorporating New York or Illinois choice of law and venue.
• Consider specific provisions in the agreement designed to maximize the effect of any non-reliance clause:
  • Insist that the buyer affirmatively acknowledge that although they have received other information in connection with the transaction, that they are not relying upon that information, and they understand that their reliance will be limited solely to the information that is the subject of the express warranties contained in the agreement itself.
  • Include a clear integration clause in the agreement that specifically references representations and warranties (vs. the customary references only to “agreements and understandings”).

When representing the buyer, advisors should consider the following:

• Weigh the impact of venue and jurisdiction provisions. A Delaware or Massachusetts exclusive jurisdiction clause could limit the effect of a non-reliance clause by invoking the AES/Rogan decisions.
• Consider including a seller’s 10b-5 representation in the agreement to obtain the benefits of a securities fraud standard in the agreement (e.g. “representations and warranties do not contain any misstatement of a material fact or omit to state a material fact necessary to prevent the statements made therein from being misleading”).
• Do not agree to a non-reliance clause in the acquisition agreement, or seek to exclude fraud/negligent misrepresentation or specific items of concern from such a clause.
• Get comfortable with the results of your due diligence and the extent of representations provided by the seller.

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