Founder was selling his company to Buyers, a private equity
outfit. He wanted to just cash out and be done. But Buyers—as private equity guys often do—wanted Founder to stick around and keep some skin in the game. So they offered part
of the consideration in equity. Founder grudgingly accepted.
Founder demanded, however, to
cap his obligation to hang around. He asked for a put option on the equity, at a fixed price, that he could
exercise after three years. But that created a tax problem because the option is certain enough
that it creates an immediate taxable event. So to avoid the tax issue, the head Buyer orally promised to buy back Founder’s shares after three
years, on the same price terms. But it was all just on a handshake. After making
it super-duper clear that was the deal—so clear that Founder made head Buyer say
“I promise” several times—Founder agreed.
So the deal got papered, and the three years went by. Those
years happened to be 2007-2010, which weren’t a particularly awesome time to be
in small cap private equity game. When it came time for Founder to exercise his put, the Buyers
said no dice. They couldn’t afford it. Litigation ensued, and Founder won a
judgment for the full put price, plus ensuing dividends, plus interest.
So the whole shebang turns on the parol evidence rule.
There’s three deal docs—a purchase agreement, a stock subscription agreement,
and a stockholder agreement. The first is governed by California law, the other
two by Delaware law. Each has a typical integration clause.
The Court finds that under both Delaware and California
law, there are two kinds of integration. The first is when a written agreement
intended to be a final expression of the parties intent, see Civil Code § 1856(a), which is called “partial
integration” in some jurisdictions. The other (higher) level is when the
parties intend their written agreement a complete and exclusive embodiment of
the agreement, see Civil Code §
1856(b), which is called a “complete integration” in some jurisdictions.
The difference between the levels is how they address additional, but
consistent, terms supposedly embodied in a prior or contemporaneous oral
agreement. In level one, the new terms can supplement the written deal. In
level two, they can’t. The only use for extrinsic evidence in level two is to explain ambiguous provisions in the written agreement.
The key difference between California and Delaware law, however,
is the weight afforded to an integration clause in deciding which level of integration
is present. California law considers the clause, but also context and
circumstances, the term of the oral promise (to the extent consistent), and
whether the written agreement appears fully integrated on its face. Generally,
it’s a fact question, although it can be a legal one if the evidence isn’t in
dispute.
Delaware law, on the other hand, tends to put more weight to a
written expression of an intent to integrate. Just how much weight exactly isn’t
entirely clear to the Court here—it says that the Delaware Supreme Court does
not appear to have definitively spoken. But the Court disentangles three veins
of trial court decisions on the issue, finding cases that say: (1) the clause
creates a presumption of complete integration that can be rebutted by extrinsic
evidence of the lack of intent to fully integrate; (2) the clause creates a
presumption of complete integration that can be rebutted, but only by evidence
of fraud or a fiduciary breach; and (3) the clause creates a conclusive
presumption. The Court notes, however, that the Delaware Supreme Court has
generally followed the Restatement (Second) of Contracts’ take on parol
evidence, which is basically category (1), and also that it has cited some
other stuff that is consistent with category (1).*
The result, then, basically follows the standard. The
evidence is pretty strong here that, notwithstanding whatever basic integration
provisions were in the contracts, the parties all intended to enter an oral
side agreement where the buyers would buy back Founder’s stock. That evidence
was certainly strong enough for there to be substantial evidence to support the
trial court’s ruling that the agreement was only a final expression/partial
integration and not a complete and exclusive/compete integration. And since
nothing in the deal docs is contrary to
that agreement, we’re in a supplementing situation where an oral side agreement
can stand up.
Affirmed.
*I’ve done some Delaware-law corporate litigation in my
day. And I’m not so sure this should be the end of it, particularly in the case of claims arising
from the purchase or sale of companies—the bread and butter of
Delaware contract law. In a very influential opinion, then-Chancellor Strine of
the Delaware Court of Chancery—who is currently the Chief Justice of the
Delaware Supreme Court—enforced a provision in a merger agreement that
disclaimed any reliance on extra-textual promises, even if those statements
were credibly alleged to have been fraudulent. See Abry Partners V, L.P. v. F & W Acquisition LLC, 891 A.2d
1032 (Del. Ch. 2006). The Chancellor’s point was that if you clearly promise that
you haven’t relied on anything outside of the four corners of the agreement, to
claim that there were, in fact, some extra contractual agreement is
itself to admit you lied in the text of the contract. As Strine saw it, to allow
a sophisticated party to prevail on that kind of claim “is to sanction its own
fraudulent conduct.”
Subsequently, the Delaware Supreme Court upheld the
rationale of Abry Partners in the
even more extreme position where the parties’ agreement stated that they
weren’t relying on anything. See RAA
Mgmt., LLC v. Savage Sports Holdings, Inc., 45 A.3d 107 (Del. 2012).
These cases and contractual provisions don’t use the
typical language of the parol evidence rule, although Abry Partners touches on
the integration issue a little in a few of its 86 footnotes. But in the
specific context at play here—interpreting M&A agreements—non-reliance
language acts as a supercharged integration clause that forecloses the use of extrinsic
evidence for any reason other than to interpret ambiguous terms that are
already in the agreements. No contradicting. No supplementing. (And unlike in
California, Delaware courts often go out of their way to avoid saying anything
is ambiguous.)
Anyway, the Court notes the agreements here had “integration
clauses,” and the language it quotes make the provisions seem more like the
typical “this Agreement is the entire agreement . . . .” stuff. That kind of integration clause isn’t enough to invoke nonreliance, see Kronenberg v. Katz, 872 A.2d 568 (Del. Ch. 2004), and the Court
doesn’t address whether there was also non-reliance language. It seems that
the parties didn’t either. (None of their briefs cite Abry Partners or RAA.) But
if a purchase agreement had this kind of non-reliance language in it—language
that has been pretty standard in private equity deal docs for quite a while—it’s
pretty likely that it would be enforced by a court in Delaware as essentially
an irrebutable presumption, lest the court permit the plaintiff to succeed by
lying “in the most inexcusable of commercial circumstances: in a freely
negotiated written contract.”
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