The use by purchasers of comprehensive due diligence request lists and carefully crafted representations and warranties is a staple of M&A transactions. Yet in deals where the seller will retain an interest in the success of the business going forward, such as where the seller receives equity in the purchaser or a right to a potential earnout as part of its consideration, the seller should likewise avail itself of these safeguards. The best protection is a representation regarding any critical issue; however, as a recent case before the Delaware Chancery Court shows, in the absence of such a representation, a party’s failure to document that it at least asked appropriate questions during due diligence may be fatal to its ability to later maintain actions for fraud.
In Airborne Health, Inc. v. Squid Soap, LP, the Delaware Chancery Court rejected the seller’s claims that the purchaser committed extra-contractual common law fraud, causing the seller to lose potential earn-out payments. The seller claimed that the purchaser, throughout the parties’ courtship, touted its strong brand name and ability to grow the seller’s business and failed to disclose pending legal proceedings threatening the purchaser’s continued success.