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Should a court enforce a contract that permits lying?

That’s the question in Vice Chancellor Strine addressed in Abry Partners V, L.P. v. F & W Acquisition LLC, 2006 WL 358236 (Del. Ch. 2/14/06).

This was a contract between two private equity firms to buy all of the shares of a publisher, F & W Publications. The contract explicitly said that buyer was not relying on representations and warranties outside the agreement. But the contract said more: that the seller was not liable for any misrepresentation within the agreement beyond damages in arbitration up to the amount in an “indemnity fund.”

The buyer is suing for rescission based on representations within the agreement, not outside. Should the contract be applied to limit buyer as to this claim?

V.C. Strine emphasized that this was a heavily negotiated agreement between two sophisticated parties. The buyer wanted some assurances from the seller, but the seller didn’t want to take total responsibility for information about the company. So the parties “precisely negotiated” how much responsibility the seller would be taking: none for facts outside the company, a limited amount for facts inside the company.

The court first had to decide what law to apply. The parties seemingly made it easy by contracting for Delaware law. But nothing is easy when it comes to litigation these days. Buyer argued that Delaware law was only supposed to apply to “contract” claims – not “tort” claims for fraud. The court said nuts to that. Delaware has a strong policy on enforcing contractual choice of law, embodied in a contractual choice of law statute. And the parties wanted certainty, which would be compromised if the court qualified the contract as buyer wanted.

The court noted that all of the business associations that were parties to the agreement were organized in Delaware. True, they had physical connections with other New England. But, the court colorfully noted, through the choice of law clause “Buckeyes, Quahogs, and Minutemen could come together using the common language of the Blue Hen, which each embraced as setting forth a reliable and fair set of rules for their commercial relationship” (slip at 13).

For more on enforcing contractual choice of law, see my From Efficiency to Politics in Contractual Choice of Law, 37 Ga. L. Rev. 363 (2003),

As for the exculpatory clause, the court didn’t evade the issue. The carefully written contract clearly limited liability even for intentional misrepresentations within the contract. So the court had to choose between the strong public policy favoring contractual freedom, in a context involving very sophisticated parties, and the difficulties of authorizing lying.

In the end, Vice Chancellor Strine held that “the public policy of this State will not permit” a contract that would insulate a seller who deliberately lied or knew that the company had made false representations (really the same thing in this case because the seller had certified the company’s representations).

Yes, it’s a difficult case, and Strine’s reasoning is thorough and cogent. But I think he made the wrong decision.

To begin with, though there’s some language in the opinion about “morality,” it doesn’t belong here, at least without a lot more explanation about what it means in this context. After all, the judge explicitly sanctioned even deliberate lies made outside the contract. The court rationalized the distinction by saying that the plaintiff itself would be a “liar” if it said it wasn’t relying on such statements and then sued for them. But why not the same reasoning about statements within the contract, if the contract clearly limits liability for these statements?

The decision might make sense if no reasonable party could have made an agreement that allowed the other party to lie in the contract. This would be an interpretive move, along the lines of good faith: we shouldn’t force the parties to spell out terms that reasonable parties surely would have understood.

But that wasn’t the case here. First, the parties had not completely eliminated liability for statements within the contract – only limited it.

Second, the question is not simply whether the seller lied, but whether we can be absolutely sure it lied given the risk, even in Delaware, of judicial error. Even if courts are perfect, after all, witnesses aren’t. The seller was reasonably contracting to avoid litigation risk.  Unfortunately, the court did not give it what it bargained for.

Third, as the court pointed out, the contract isn’t the only constraint: there are strong reputational constraints within the relatively small private equity community to which both firms belonged.

The bottom line is that, as the court recognized, you’re never going to get a better situation for enforcing the contract as written, or a clearer contract. It should have been enforced, as distasteful as this might sound to some folks.

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Listed below are links to weblogs that reference Should a court enforce a contract that permits lying? :

» Should a court enforce a contract that permits lying? from PointOfLaw Forum
That's the question Delaware Vice Chancellor Strine faced in a recent case. As distasteful as it may sound, sometimes the parties should be able to keep even lying out of the grasp of error-prone courts. That’s particularly so when you... [Read More]

» Contracting to Lie from Conglomerate
Two private equity firms negotiate a contract for the sale of a portfolio company. One of the firms makes [Read More]

» Contracting to Lie from Conglomerate
Two private equity firms negotiate a contract for the sale of a portfolio company. One of the firms makes [Read More]

» Enforceability of Contract that Allows Lying from Delaware Litigation
Prof. Larry Ribstein has a thoughtful post on a recent Chancery decision discussing the enforceability of a contract that allows misrepresentations. Abry Partners V, L.P. v. F & W Acquisition LLC, 2006 WL 358236 (Del. Ch. 2/14/06). Here is the... [Read More]

» Short takes from ProfessorBainbridge.com
Larry Ribstein makes a very persuasive case for the proposition that Delaware Vice Chancellor Strine should have enforced a contract that permits lying; Gordon Smith agrees A very interesting article on the (new to me) phenomenon of Siamese Twin stocks [Read More]

Comments

The opinion is available free at the Delaware courts' website. I think this address should work:

http://courts.delaware.gov/opinions/(xjdlbg2orlgze345sjcd0quc)/download.aspx?ID=72140

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