Chancery Provides "Teachable Moment" for M & A Lawyers: Find Problems of Bidder in Due Diligence or Put Specific Reps in APA; Otherwise No Fraud Claim

Chancery Provides "Teachable Moment" for M & A Lawyers: Find Problems of Bidder in Due Diligence or Put Specific Reps in APA; Otherwise No Fraud Claim

Airborne Health, Inc. v. Squid Soap, L.P., C.A. No. 4410-VCL (Del. Ch. July 20, 2010), read opinion here.  Prior Delaware Court of Chancery decisions in this case were highlighted here.


This case involves a claim against the purchaser of a company and its major law firm for fraud in connection with an Asset Purchase Agreement (APA). The essence of this business litigation claim is that the purchaser, Airborne, fraudulently induced the seller, Squid Soap, to enter into the APA based on misrepresentations about Airborne's ability to grow Squid Soap's business under Airborne's supposedly superior auspices. After the APA closed, major costs incurred by Airborne in connection with the settlement of a class action lawsuit and regulatory investigations, that were pending prior to the APA, severely hampered Airborne and impaired its ability to grow Squid Soap--so much so that Squid Soap claims that after the APA closed, Airborne "killed Squid Soap in its infancy". The Court granted a motion to dismiss the claims.

Legal Analysis

Squid Soap claimed that Airborne was liable to it based on extra-contractual common law fraud. The Court recited the five elements for such a cause of action at pages 12 and 13 of the slip opinion, and also described the three species of fraud, each of which was asserted by Squid Soap: (1) affirmative falsehood; (2) active concealment; and (3) breach of duty to speak. The Court analyzed each in turn. The Court's "teachable moment" to M & A lawyers is offered in part two below.

(1) No Affirmative Falsehood

The Court found that Airborne did not make a material misrepresentation of fact either outside the agreement or in the APA. The representations described at page 10 of the slip opinion regarding the pending litigation against Airborne were sparse and not breached. After reciting the extensive statements made by Airborne to induce Squid Soap to do the deal, the Court described them all as "mere puffery" that because of vagueness are "immunized from regulation". Airborne's bragging about its "very strong brand name" and "established market presence" were not statements that Squid Soap should have relied on. According to the Court: : "A sophisticated seller like Squid Soap, advised by expert counsel, could not reasonably rely on Airborne's boasts and blandishments."

(2) No Active Concealment

The Court observed that Squid Soap's counsel was an AmLaw 100 firm that the Court expected to have "asked questions" based on due diligence checklists and questionnaires that the Court said should have been discussed with Airborne as part of the negotiations for the APA. Footnote 1 of the opinion provided several sources where such checklists are available. The Court found nothing in the record to suggest that Squid Soap's counsel either asked questions before the closing on the APA about the litigation that became problematic, or that Airborne withheld information about the litigation if requested to provide it. Nor did Airborne offer a "half-truth designed to put Squid Soap off the scent ...." Teachable moment: The Court expects M & A lawyers (at least at major firms) to use due diligence checklists or questionnaires to ask about key facts, such as pending litigation, before a deal is consummated, and/or provide for specific representations in the APA about such key facts. Otherwise, a subsequent fraud claim will face an uphill battle.

(3) No Duty to Speak

There was no exception based on a special relationship between the parties, so the Court described the general rule that "one party to a contract is under no duty to disclose facts of which he knows the other is ignorant even if he further knows the other, if he knew of them, would regard them to be material in determining his course of action in the transaction in question." (citing Restatement (Second) of Torts, Section 551 cmt a (1977)). That is, if one's M & A lawyer does not ask about key material facts, and does not obtain representations about those key material facts that later become a source of problems after the deal closes, one should not expect a fraud claim based on non-disclosure of those material facts to have a high probability of success.

Nor did the Court find a disclosure obligation based on a partial disclosure that left a misleading impression even if the partial disclosure was technically true. As a result, in concluding its opinion, the Court dismissed the aiding and abetting claims against the buyer's law firm.

Read more Delaware business litigation case summaries and commentary on Delaware Corporate and Commercial Litigation Blog, a blog hosted by Francis G.X. Pileggi, of Fox Rothschild LLP.