IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE SPARTON CORPORATION, an Ohio Corporation, ) ) Plaintiff, ) ) v. ) C.A. No. 12403-VCMR ) JOSEPH F. O’NEIL, PETER DUMANIAN, TODD ) MOUTAFIAN, JASON LEVY, JASON SEIFERT, ) THOMAS J. YORKEY, WALTER E. GORDON, ) THOMAS W. PARKER, MARK EVANS, CARMEN ) GONZALEZ, HAI CAO NGUYEN, BILLY CHEN, ) HASSAN MALAK, PHILIP J. AGUIAR, THUY ) THANH THI NGUYEN, CHERYL MARIE ) PITTMAN-LEWIS, DANIEL T. JACKSON, ) JOSEPH R. WEEMS, GREGORY A. EDGMON, ) RICHARD N.C. MICAEL, BEN MCDERMOTT, TY ) VAN LE, SCOTT A. ZELGEWICZ, JOSEPH P. ) LOEFFLER, CHRISTOPHER J. ALESSIO, AND ) IAN GROVER, ) ) Defendants. ) ) JOSEPH F. O’NEIL, in his capacity as Representative ) of the former Stockholders and Optionholders of ) Hunter Technology Corporation, ) ) Counterplaintiff, ) ) v. ) ) SPARTON CORPORATION, ) ) Counterdefendant. )
MEMORANDUM OPINION Date Submitted: June 6, 2017 Date Decided: August 9, 2017 Richard M. Beck and Sean M. Brennecke, KLEHR HARRISON HARVEY BRANZBURG LLP, Wilmington, Delaware; Joseph J. Shannon, BODMAN PLC, Detroit, Michigan; Attorneys for Plaintiff.
William M. Lafferty, John P. DiTomo, and Zi-Xiang Shen, MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware; Mark A. Schwartz and Sandra J. Durkin, BUTLER RUBIN SALTARELLI & BOYD LLP, Chicago, Illinois; Attorneys for Defendants.
MONTGOMERY-REEVES, Vice Chancellor. This action involves a merger in which Sparton Corporation (“Sparton”), the
purchaser, alleges that the merger agreement was fraudulently induced. Sparton
argues that Joseph F. O’Neil, the representative of the stockholders and
optionholders of Hunter Technology Corporation (“Hunter”), the seller, with the
assistance of the other defendants, created and presented false financial statements
during the negotiations. Based on these fabricated financials, the parties agreed to a
pre-closing estimate of Hunter’s working capital, an escrow amount, and a cap on
the post-closing adjustment of working capital. Prior to the closing, without
Sparton’s knowledge, the defendants allegedly wrote down the accounts receivable,
returning Hunter’s working capital to its correct lower value. After the transaction,
Sparton discovered that the working capital actually was much lower than originally
thought, and the agreed-upon escrow amount was inadequate to cover the difference.
Sparton argues that defendants’ fraudulent actions caused millions in damages.
Sparton also asserts a breach of contract claim against the stockholders and
optionholders of Hunter, alleging that Hunter’s financial statements and accounts
receivable did not accurately represent its working capital in breach of the warranties
contained in the merger agreement (the “Working Capital Claim”). Additionally,
Sparton asserts that O’Neil failed to use commercially reasonable efforts to resolve
certain liabilities that Hunter incurred before the transaction in breach of the merger
agreement (the “Specific Indemnity Claims”), and the defendants incurred but failed
1 to pay certain invoices, as required under the agreement (the “Expenses Claim”). As
a result of the purported fraud and contractual breaches, Sparton alleges it has
suffered (1) $1,829,455.00 in damages representing the difference between the
inflated working capital it paid for and the working capital that actually existed at
closing; (2) unliquidated damages in the amount of fees and costs necessary to
resolve the liabilities that O’Neil promised to resolve; and (3) $100,498.70 in
damages for the invoices incurred by Hunter for which Sparton now is responsible.
The defendants move to dismiss all claims except the Expenses Claim. The
defendants argue that the merger agreement bars both breach of contract claims
because the agreement provides exclusive remedies for the purported breaches.
Additionally, the defendants contend that Sparton has failed to state a claim for the
Specific Indemnity Claims. As to the Working Capital Claim, the agreement’s
exclusive remedy provision provides a fraud exception; but, the defendants argue
that (1) the agreement contains an anti-reliance provision; (2) the defendants did not
make any representations to Sparton in the contract regarding the veracity of the
financial statements that could form the basis for the fraud claim; and (3) Sparton
fails to meet the heightened pleading standard required to state a claim for fraud.
For the reasons discussed below, I find that the agreement bars both breach of
contract claims and that Sparton has failed to state a claim for fraud. Therefore, the
motion to dismiss is granted in its entirety.
2 I. BACKGROUND All facts are drawn from the First Amended Verified Complaint (the
“Complaint”) and the documents incorporated by reference therein.1
A. Parties and Relevant Non Parties Plaintiff Sparton Corporation (“Sparton”) is a company incorporated in Ohio
with its principal place of business in Schaumberg, Illinois. Non-party Hunter
Technology Corporation (“Hunter” or the “Company”) is a California corporation.
Non-party Sparton Hunter Corporation (“Merger Sub”) was Sparton’s subsidiary
formed to effectuate the merger between Hunter and Sparton, with Hunter as the
surviving wholly-owned subsidiary of Sparton.
Defendants Joseph F. O’Neil, Peter Dumanian, Todd Moutafian, Jason Levy,
and Jason Seifert were stockholders of Hunter before the transaction (collectively,
the “Stockholders”). Defendants Thomas J. Yorkey, Walter E. Gordon, Thomas W.
Parker, Mark Evans, Carmen Gonzalez, Hai Cao Nguyen, Billy Chen, Hassan
Malak, Philip J. Aguiar, Thuy Thanh Thi Nguyen, Cheryl Marie Pittman-Lewis,
Daniel T. Jackson, Joseph R. Weems, Gregory A. Edgmon, Richard N.C. Micael,
Ben McDermott, Ty Van Le, Scott A. Zelgewicz, Joseph P. Loeffler, Christopher J.
1 In re Morton’s Rest. Gp., Inc. S’holders Litig., 74 A.3d 656, 659 n.3 (Del. Ch. 2013). Here, the merger agreement between Hunter Technology Corporation, Sparton Corporation, Sparton Hunter Corporation, and Joseph F. O’Neil is incorporated by reference and attached as Exhibit A to the Complaint (hereinafter, the “Agreement”).
3 Alessio, and Ian Grover were optionholders of Hunter before the transaction
(collectively, the “Optionholders”).
B. Facts
On April 14, 2015, Sparton, Hunter, Merger Sub, and O’Neil executed a
merger agreement through which Sparton acquired Hunter (the “Agreement”).
O’Neil negotiated and executed the Agreement as the “representative, agent, proxy,
and attorney in fact (coupled with an interest) for all the Stockholders and
Optionholders for all purposes under this Agreement . . . .” 2 As a result of the
transaction, the Stockholders and Optionholders received $55,000,000.00 in
exchange for the cancellation of their shares and outstanding options. The resolution
of the pending motion to dismiss requires an examination of certain contractual
provisions of the Agreement and, in some instances, the negotiations surrounding
those provisions.
1. The representations and warranties Hunter provided the following representations and warranties in Article V of
the Agreement:
The Financial Statements have been based upon the information contained in the Company’s and its Subsidiaries’ books and records (which are true and complete in all material respects, have been maintained consistently with past practices, and have been made available for inspection by Purchaser or its
2 Agreement § 13.13(a).
4 representatives), have been prepared in conformity with GAAP, and present fairly in all material respects the financial condition and results of operations of the Company and its Subsidiaries as of the times and for the periods referred to therein. . . .3
Except as set forth on the Developments Schedule, since September 30, 2014, there has not been any Material Adverse Change.4
Thus, the Company represented that the financial statements were based on the
Company’s books and records (which were accurate), prepared in accordance with
GAAP principles, and “present[ed] fairly in all material respects the financial
condition and results of operations of the Company.”5
The Optionholders and Stockholders agreed to indemnify Sparton for any
losses incurred as a result of “any breach of, or any misrepresentation with respect
to, any of the representations and warranties expressly and specifically set forth in
Article V.”6 Article V includes the Company’s representation regarding the
financial statements’ accuracy. But the indemnification provision precludes
recovery for any loss “included in the calculation of the final Allocable Amount,”
3 Id. § 5.05. 4 Id. § 5.06. 5 Id. § 5.05. 6 Id. § 11.01.
5 except in the case of fraud.7 The “Allocable Amount” includes a calculation to adjust
for changes to the Company’s working capital.8
2. The working capital
To account for Hunter’s working capital variation over time, the parties agreed
that they would use a pre-closing estimate of working capital based on Hunter’s
March 31, 2015 financial statements and a post-closing working capital adjustment.
Section 3.03 of the Agreement provides that at least three business days before
closing, “the Company shall prepare and deliver to the Purchaser a good faith
estimate of the Allocable Amount based on the Company’s books and records and
other information then available.”9 As discussed above, working capital is included
in the calculation of the Allocable Amount.10 If within five business days after the
final Allocable Amount is determined, the actual Allocable Amount is less than the
estimate, then the escrow agent will pay Sparton the amount of the deficiency from
the Purchase Price Adjustment Escrow Funds. Any such payments “shall be the sole
and exclusive remedy of the Purchaser for any and all claims arising under this
7 Id. § 11.01(e). 8 Id. § 1.01. 9 Id. § 3.03(a). 10 See supra Section I.B.1.
6 Agreement with respect to this Section 3.03.”11 Section 13.14(b) echoes Section
3.03, adding that Sparton “agrees and acknowledges that its right to any payment
made pursuant to Section 3.03(h)(i) . . . shall be the Purchaser’s sole and exclusive
source of recovery for any amounts owing to the Purchaser pursuant to Section
3.03(h)(i), except for claims for Fraud.”12
On April 10, 2015, Hunter, Sparton, and the Stockholders agreed to the pre-
closing estimate of working capital. Based on this estimate and “O’Neil’s
representation that any resulting post-closing working capital adjustment would be
minimal, and at Defendant O’Neil’s insistence,”13 the parties agreed that the working
capital adjustment was capped at $750,000.00 and was the exclusive remedy for any
overstatement of the working capital, except in the case of fraud.
Sparton alleges that before the working capital estimate was calculated,
O’Neil, with assistance from Alessio, Nguyen, Edgmon, Evans, “and others, made
non-GAAP adjustments to Hunter’s accounts receivable, thereby artificially
overstating the value of Hunter’s accounts.”14 This included “adding amounts to
invoices that were not owed to Hunter, including invoicing customers for work that
11 Agreement § 3.03(h). 12 Id. § 13.14(b). 13 Compl. ¶ 54. 14 Id. ¶ 55.
7 Hunter had not yet completed and for which it did not yet have the right to payment,
and invoicing for obsolete inventory where Hunter had no right or expectation of
payment.”15 Sparton contends that between April 10 and April 13, after Sparton had
accepted the working capital estimate and agreed to the $750,000.00 escrow amount
and cap, but before closing, “Defendants O’Neil, Alessio, Nguyen, Edgmon, Evans,
and others purposefully caused Hunter to write off the overstated invoices, reverting
Hunter’s working capital to its actual, lower value.”16 Sparton alleges that “[m]any
of these adjustments were made on Sunday April 12, 2015.”17 Sparton asserts that
as a result of this conduct, “Sparton overpaid for Hunter’s working capital by
$2,579,455.00.”18
Sparton presented O’Neil with its post-closing working capital adjustment of
$2,579,455.00, and O’Neil did not dispute the amount but rather released the entire
$750,00.00 working capital escrow amount to Sparton. Sparton then requested an
additional $550,000.00 from the indemnity escrow fund to mitigate its working
capital damages. O’Neil objected to this request, and the indemnity escrow funds
have not been released.
15 Id. ¶ 56. 16 Id. ¶ 58. 17 Id. 18 Id. ¶ 62.
8 3. The specific indemnity schedule As part of the Agreement, O’Neil would “have responsibility for managing,
handling and controlling the defense, settlement or other disposition of the matters
set forth” in the Specific Indemnity Schedule. O’Neil was obligated to “use
commercially reasonable efforts to settle on commercially reasonable terms the
matters set forth on this Specific Indemnity Schedule within 18 months of the
Closing Date.” 19 O’Neil also was to “provide Purchaser with information regarding
the process of such settlements upon Purchaser’s written request.”20 Additionally,
“if any matters remain unresolved as of September 1, 2016, at the Purchaser’s written
request, the Representative and Purchaser shall meet to discuss the planned
resolution of such remaining open matters.”21
The indemnification provision provides the remedy for losses related to “any
of the matters set forth on the Specific Indemnity Schedule” if they “are actually
incurred prior to October 14, 2016,” but it “shall not cover potential Losses from
matters that are pending or otherwise have not been resolved prior to October 14,
2016.”22 In other words, the obligation to indemnify Sparton for the matters listed
19 Agreement Disclosure Schedules, at 60. 20 Id. 21 Id. 22 Id. § 11.01.
9 on the Specific Indemnity Schedule terminates on October 14, 2016 “regardless if
any claims are still pending or the matters set forth on the Specific Indemnity
Schedule remain pending and have not been settled or otherwise resolved . . . .23 A
Specific Indemnity Claim only arises once Sparton “actually incurs any out-of-
pocket Losses indemnifiable under Section 11.01(iii) of the Merger Agreement or
there is a judgment or settlement permitted by the Merger Agreement of any matter
covered by Section 11.01(iii) of the Merger Agreement.”24 The Specific Indemnity
Claims are Sparton’s sole and exclusive remedy for losses related to matters listed
on the Specific Indemnity Schedule, except in the case of fraud.25
The Specific Indemnity Schedule lists the matters it covers, including (a) the
California State Board of Equalization (the “SBOE”)’s determination of tax liability
in early 2014 of $1,436,968.29 plus accruing interest arising from a company Hunter
acquired in 2013; $130,000.00 in sales tax that the acquired company did not report
or remit to the SBOE; and certain unrealizable assets prepaid by Hunter, totaling
$154,577.00; and (b) the California Department of Toxic Substances Control
(“DTSC”)’s cleanup claim against 60 parties including Hunter regarding a hazardous
waste repackaging facility called Ultra-Chem. The Complaint alleges that Sparton
23 Id. § 11.04. 24 Id. Ex. C § 4(e)(vi). 25 Id. § 11.02.
10 remains liable for both of these unresolved claims due to O’Neil’s lack of
“commercially reasonable efforts” to resolve them.26
4. The anti-reliance provision
The Agreement contains an anti-reliance provision that states as follows:
The representations and warranties of the Company expressly and specifically set forth in Article V (together with any representations and warranties expressly and specifically made by the Stockholders and Optionholders in their respective Letters of Transmittal and Option Cancellation Agreements), as qualified by the Disclosure Schedules, constitute the sole and exclusive representations, warranties, and statements (including by omission) of any kind or nature, whether written or oral, expressed or implied, statutory or otherwise (including, for the avoidance of doubt, relating to quality, quantity, condition, merchantability, fitness for a particular purpose or conformity to samples) of any of the Company, the Stockholders and Optionholders, the Representative or any of their respective Non-Recourse Parties as to any matter concerning the Company, any of its Subsidiaries or any of their respective joint ventures or businesses or in connection with this Agreement or the transactions contemplated by this Agreement, or with respect to the accuracy or completeness of any information provided to (or otherwise acquired by) the Purchaser or the Merger Sub or any of their respective Non-Recourse Parties in connection with this Agreement or the transactions contemplated by this Agreement (including, for the avoidance of doubt, any statements, information, documents, projections, forecasts or other material made available to the Purchaser, the Merger Sub or any of their respective Non-Recourse Parties in certain “data rooms” or presentations including “management presentations”) and all other purported representations and warranties or
26 Id. Disclosure Schedules, at 60. 11 statements (including by omission) are hereby disclaimed by the Company, the Stockholders and Optionholders, the Representative and each of their respective Non-Recourse Parties and none of the Purchaser or the Merger Sub or any of their respective Non-Recourse Parties shall have any claim with respect to their purported use of, or reliance on, any such representations, warranties or statements (including by omission). The Purchaser and the Merger Sub are otherwise acquiring the Company, its Subsidiaries, its joint ventures and their respective businesses on an “AS IS, WHERE IS” basis.27
Thus, Sparton agreed that it did not rely on anything outside the representations and
warranties contained in the Agreement in executing the Agreement.
C. Procedural History Sparton filed its original complaint in this action on June 2, 2016. On July
22, 2016, the Defendants filed their answer, counterclaims, and partial motion to
dismiss. On August 11, 2016, Sparton answered the Defendants’ counterclaims. On
September 14, 2016, Sparton filed the Complaint. On October 14, 2016, the
Defendants filed their answer, amended and supplemental counterclaims, and partial
motion to dismiss the Complaint. On November 7, 2016, Sparton filed its answer to
the amended and supplemental counterclaims. On June 6, 2017, this Court held oral
argument on the partial motion to dismiss the Complaint.
27 Id. § 10.01.
12 II. ANALYSIS
A. Standard of Review The Defendants move to dismiss for failure to state a claim under Court of
Chancery Rule 12(b)(6). For the purposes of a motion to dismiss under Rule
12(b)(6),
(i) all well-pleaded factual allegations are accepted as true; (ii) even vague allegations are “well-pleaded” if they give the opposing party notice of the claim; (iii) the Court must draw all reasonable inferences in favor of the non-moving party; and (iv) dismissal is inappropriate unless the “plaintiff would not be entitled to recover under any reasonably conceivable set of circumstances susceptible of proof.”28
While I must draw all reasonable inferences in the plaintiff’s favor, I need not
“accept as true conclusory allegations ‘without specific supporting factual
allegations.’”29
B. Sparton Fails to State a Claim for Breach of Contract In order to allege a breach of contract, a plaintiff must show the existence of
a contract, a breach of the contractual obligations, and damages to the plaintiff as a
28 In re Gen. Motors (Hughes) S'holder Litig., 897 A.2d 162, 168 (Del. 2006) (quoting Savor, Inc. v. FMR Corp., 812 A.2d 894, 896-97 (Del. 2002)). 29 Id. (quoting In re Santa Fe Pac. Corp. S’holder Litig., 669 A.2d 59, 65-66 (Del. 1995)).
13 result of the breach.30 Sparton alleges that the Defendants breached the contractual
provisions relating to the Specific Indemnity Schedule and the working capital
estimate.
Under the Agreement, the sole and exclusive remedy for losses relating to the
matters set forth in the Specific Indemnity Schedule are claims against the indemnity
escrow fund; but that indemnification obligation ended on October 14, 2016
“regardless if any claims are still pending or the matters set forth on the Specific
Indemnity Schedule remain pending and have not been settled or otherwise resolved
. . . .”31 Additionally, a Specific Indemnity Escrow Claim does not arise until Sparton
actually incurs out-of-pocket losses, a judgment is issued, or settlement is reached.32
Sparton argues that it should be “excused from complying with the dispute
procedures” set out in the Agreement because “Defendants’ conduct has made exact
conformance to the Merger Agreement impossible.”33 The sum total of Sparton’s
allegations in the Complaint are that O’Neil “failed to make commercially
reasonable efforts” to resolve Hunter’s liabilities because they were not resolved by
30 Osram Sylvania Inc. v. Townsend Ventures, LLC, 2013 WL 6199554, at *6 (Del. Ch. Nov. 19, 2013) (citing Bakerman v. Sidney Frank Imp. Co., 2006 WL 3927242, at *19 (Del. Ch. Oct. 10, 2006)). 31 Agreement §§ 11.01; 11.02; 11.04. 32 Id. Ex. C § 4(e)(vi). 33 Pl.’s Opp’n Br. 17.
14 October 14, 2016, and “[a]s a result, Sparton remains liable for unresolved claims
originally asserted against Hunter which Defendant O’Neil should have, and could
have, resolved using commercially reasonable efforts.”34 The Complaint provides
no details about how O’Neil did not meet this requirement or why “Defendants’
conduct has made exact conformance to the Merger Agreement impossible.”35 The
conclusory allegation that O’Neil did not use commercially reasonable efforts to
resolve the matters because the matters remain unresolved is not enough to state a
claim under Rule 12(b)(6).36 Therefore, this claim is dismissed.
With regard to the Working Capital Claim, the Agreement in Section
3.03(h)(i)(A) provides that if the Allocable Amount determined after closing is less
than the Estimated Allocable Amount, the buyer and the representative shall “cause
the Escrow Agent to: (A) pay to the Purchaser from the Purchase Price Adjustment
34 Compl. ¶¶ 78, 81, 103, 104, 105. 35 Pl.’s Opp’n Br. 17. 36 Sparton alleges facts in its briefing on this motion that do not appear in the Complaint. But Sparton offers no explanation for its attempt to amend the Complaint through its brief. “When defendants filed their motions to dismiss [Plaintiff] had a choice to make under Court of Chancery Rule 15(aaa). It could either seek leave to amend its complaint or stand on its complaint and answer the motion to dismiss. Having chosen the latter course of action, it is bound to the factual allegations contained in its complaint. It cannot supplement the complaint through its brief.” MCG Capital Corp. v. Maginn, 2010 WL 1782271, at *5 (Del. Ch. May 5, 2010).
15 Escrow Funds an amount . . . equal to such deficiency.”37 The Agreement further
provides that the “payments described in Section 3.03(h)(i) shall be the sole and
exclusive remedy of the Purchaser for any and all claims arising under this
Agreement with respect to this Section 3.03.”38 Section 13.14 adds that Sparton
agrees that the “sole and exclusive source of recovery for any amounts” owed under
Section 3.03(h)(i) is its right to payment under that section, “except for claims for
Fraud.”39 Additionally, except in the case of fraud, any loss attributable to amounts
included in the calculation of the final Allocable Amount, which includes working
capital, cannot be recovered from the indemnity escrow fund.40
Sparton does not dispute the applicability of these contractual terms and
admits that it has received the full $750,000.00 from the Purchase Price Adjustment
Escrow Fund. Sparton argues that this claim should survive the motion to dismiss
because the contract was fraudulently induced, and therefore, any contractual
limitations do not apply. This claim, thus, rises and falls with the fraud claim, which
37 Agreement § 3.03(h)(i)(A). 38 Id. § 3.03(h). 39 Id. § 13.14(b). 40 Id. § 11.01(e).
16 I discuss below. As I find that Sparton has not adequately alleged a claim for fraud,
this claim also is dismissed.41
C. Sparton Fails to State a Claim for Fraud
In order to state a claim for fraud, a plaintiff must allege that (1) the defendants
made a false representation or omission of fact that they had a duty to disclose; (2)
the defendants knew or believed that the representation was false or made the
representation with reckless indifference to the truth; (3) the defendants intended to
induce the plaintiff to act or refrain from acting; (4) the plaintiff acted or did not act
in justifiable reliance on the representation; and (5) the plaintiff suffered damages as
a result of the reliance.42
Court of Chancery Rule 9(b) requires that “the circumstances constituting
fraud [] shall be stated with particularity,” while “[m]alice, intent, knowledge and
other condition of mind of a person may be averred generally.” 43 “To satisfy Rule
9(b), a complaint must allege: (1) the time, place, and contents of the false
41 See infra Section II.C. 42 Addy v. Piedmonte, 2009 WL 707641, at *18 (Del. Ch. Mar. 18, 2009); Abry P’rs V, L.P. v. F & W Acquisition LLC, 891 A.2d 1032, 1050 (Del. Ch. 2006). 43 Ct. Ch. R. 9(b); Addy, 2009 WL 707641, at *19; Abry, 891 A.2d at 1050.
17 representation; (2) the identity of the person making the representation; and (3) what
the person intended to gain by making the representations.”44
1. Sparton cannot rely on extra-contractual representations
The Agreement contains an anti-reliance provision. In Delaware, “[w]e have
honored clauses in which contracted parties have disclaimed reliance on extra-
contractual representations, which prohibits the promising party from reneging on
its promise by premising a fraudulent inducement claim on statements of fact it had
previously said were neither made to it nor had an effect on it.”45 Here, Section
10.01 provides that
the representations and warranties of the Company expressly and specifically set forth in Article V (together with any representations and warranties expressly and specifically made by the Stockholders and Optionholders in their respective Letters of Transmittal and Option Cancellation Agreements), as qualified by the Disclosure Schedules, constitute the sole and exclusive representations, warranties and statements (including by omission) of any kind or nature . . . of any of the Company, the Stockholders and Optionholders, the Representative or any of their respective Non-Recourse Parties.46
44 Abry, 891 A.2d at 1050 (citing H-M Wexford LLC v. Encorp, Inc., 832 A.2d 129, 145 (Del. Ch. 2003)); see Addy, 2009 WL 707641, at *19. 45 Abry, 891 A.2d at 1056. 46 Agreement § 10.01.
18 Thus, Sparton may only rely on “representations, warranties and statements”
included in the Agreement and in the attached documents. Sparton cannot rely on
representations made by O’Neil or anyone else before the transaction.
2. The indemnification limitations do not apply in cases of fraud Sparton points to the financial statements attached to the Agreement and
argues that the Company falsely represented that the financial statements were based
on the Company’s books and records, which are true and complete, prepared in
conformity with GAAP, and “present[ed] fairly in all material respects the financial
condition and results of operations of the Company and its subsidiaries as of the
times and for the periods referred to therein . . . .”47
Although the Company, not the Stockholders or Optionholders, made the
pertinent representations in Article V,48 the Stockholders and Optionholders agreed
to indemnify Sparton for any “breach of, or any misrepresentation with respect to,
any of the representations and warranties expressly and specifically set forth in
Article V.”49 As discussed above, this provision contains a carve-out for any losses
stemming from amounts included in the calculation of the Allocable Amount, which
47 Id. § 5.05. 48 Id. § 5.05 (emphasis added). 49 Id. § 11.01.
19 includes working capital, but the limitation does not apply in the case of fraud.50
Therefore, I must determine whether Sparton has adequately alleged a claim for
fraud.
3. Sparton’s fraud claims fail Sparton’s allegations do not meet the heightened pleading standard required
to show fraud. Sparton alleges that O’Neil negotiated the Agreement on behalf of
the Stockholders and Optionholders. This included establishing the working capital
estimate that was based on the inflated accounts receivable in the financial
statements. Sparton alleges that O’Neil “fraudulently overstated Hunter’s accounts
receivable with assistance from Defendants Alessio, Nguyen, Edgmon, Evans, and
others.”51 This allegedly was done by making non-GAAP adjustments to the
accounts receivable through the addition of amounts to invoices that were not owed
to Hunter, including for work Hunter had not yet completed, for which Hunter had
no expectation of payment, or for obsolete inventory.52 Sparton asserts that
“alternately,” Defendants O’Neil, Alessio, Nguyen, Edgmon, Evans, “and others”
50 Agreement §§ 11.01(e), 1.01; see supra Section II.B; Abry, 891 A.2d at 1061-64. 51 Compl. ¶ 121. 52 Id. ¶ 56.
20 wrote down “existing accounts receivable in non-GAAP transactions after their full
value had already been included in Hunter’s Working Capital Estimate.”53
These Defendants, the Complaint asserts, had an “express intent” to inflate
the value of Hunter’s assets to artificially increase the amount of the working capital
estimate. Further, O’Neil represented that a working capital escrow of $750,000.00
would cover any post-closing working capital adjustment and provided Sparton with
Hunter’s March 31, 2015 financial statements, which Sparton purportedly
reasonably relied on in executing the merger. After Sparton had agreed to the
estimate and the escrow amount, but before closing, Sparton asserts that the same
Defendants “purposefully caused Hunter to write off the overstated invoices,
reverting Hunter’s working capital to its actual lower value.”54 Thus, Sparton
alleges, it grossly overpaid for Hunter’s working capital by millions of dollars, and
O’Neil ensured that Sparton would only be able to recover $750,000.00 under the
Agreement.
Sparton alleges that the Stockholders and Optionholders knew that Sparton
would rely on O’Neil’s representations to Sparton on behalf of Hunter, ratified
O’Neil’s fraudulent acts by accepting the merger consideration, and personally
53 Id. 54 Id. ¶ 58.
21 benefitted from O’Neil’s fraudulent misrepresentations. Thus, Sparton argues, they
are liable for the fraud O’Neil purportedly committed in his capacity as their
representative.
First, in order for the fraud claim to survive the motion to dismiss, Sparton is
“required to identify specific acts of individual defendants”55 and to “identify who
made any particular misrepresentation and to whom they were made.”56 Sparton
lists the names of certain Defendants “and others” and states that they “assisted”
O’Neil but does not identify who specifically did what or how they “assisted” in
allegedly misstating the invoices or financial statements. And in its briefing, Sparton
acknowledges that it cannot “yet identify the specific roles of the co-conspirators.”57
These allegations fail to satisfy Rule 9(b).
Second, as to the details regarding the purported fraud, the Complaint alleges
that this group of Defendants “fraudulently overstated Hunter’s accounts receivable”
by “adding amounts to invoices that were not owed to Hunter.”58 Sparton contends
that this group then “caused Hunter to write off the overstated invoices, reverting
55 Fortis Advisors LLC v. Dialog Semiconductor PLC, 2015 WL 401371, at *8 n.48 (Del. Ch. Jan. 30, 2015) (quoting Steinman v. Levine, 2002 WL 31761262, at *15 (Del. Ch. Nov. 27, 2002)). 56 Id. at *8. 57 Pl.’s Opp’n Br. 20. 58 Compl. ¶¶ 56, 121.
22 Hunter’s working capital to its actual, lower value.”59 Sparton does not identify the
invoices or the amount by which they were doctored. Also, Sparton does not allege
if these invoices were falsely created before or after the deal was negotiated. This
information is relevant here because evidence showing that the invoices were created
before the deal was negotiated would undercut Sparton’s theory that the invoices
were falsely created to boost the Company’s financials for the sale.
Third, although knowledge may be alleged generally under Rule 9(b), if
Sparton is alleging that the Defendants knew of the purported fraud, “it must allege
sufficient facts from which it can reasonably be inferred that this ‘something’ was
knowable and that the defendants were in a position to know it.”60 Sparton points to
Osram Sylvania Inc. v. Townsend Ventures, LLC61 as an example of a case that
satisfies the pleading requirement. In Osram, the named defendants negotiated and
personally entered into the stock purchase agreement. They also severally
represented that the financial statements were “correct and complete in all material
respects,” “prepared in accordance with the books and records” of the acquired
companies, and prepared “in accordance with GAAP.”62
59 Id. ¶ 58. 60 Abry P’rs V, L.P. v. F & W Acquisition LLC, 891 A.2d 1032, 1050 (Del. Ch. 2006). 61 2013 WL 6199554, at *1 (Del. Ch. Nov. 19, 2013). 62 Compl. Ex. A, at 26, 29, Osram, C.A. No. 8123-VCP (Del. Ch. Dec. 19, 2012).
23 After closing, the plaintiff conducted an investigation and found that the
individual defendants (1) had altered the size and nature of the company’s business
segments on the company’s financials before closing, (2) knew before closing that
two salespeople who accounted for 32% of the company’s sales forecast had
resigned, and (3) knew that the company had significant liabilities that it did not
disclose or otherwise account for in its financial statements.63 The investigation also
uncovered that the individual defendants were privy to internal e-mails sent
immediately before the closing. The emails discussed the company’s “cash
problem” if the deal did not close imminently and suggested that the individual
defendants buy the company’s product in order to strengthen the company’s revenue
numbers during negotiations.64 The Court in Osram noted that “a mere allegation
that a defendant ‘knew or should have known’ about a false statement is not
sufficient to plead the requisite state of mind.”65 But in that case, the e-mails
“support[ed] an inference that Sellers falsely were trying to bolster the financial
63 Osram, 2013 WL 6199554, at *3. 64 Id.; Compl. ¶ 48(j), Osram, C.A. No. 8123-VCP (Del. Ch. Dec. 19, 2012). 65 Osram, 2013 WL 6199554, at *14 (citing Stuchen v. Duty Free Int’l Inc., 1996 WL 33167249, at *5 (Del. Super. Apr. 22, 1996)).
24 condition of the Company” and “were knowing participants in an effort to defraud
OSI.”66
Here, in an attempt to satisfy the knowledge requirement, Sparton alleges that
O’Neil was involved in the negotiations, and “it would make little sense to imply”
that O’Neil, as representative of the Stockholders and Optionholders, “would not
have knowledge of the financials of the company whose interest he purports to
represent.”67 Sparton also argues that “as Stockholders and Optionholders in the
Company,” the Defendants “are charged with the knowledge held by their
Representative in the transaction.”68 But, as discussed above, none of the
Stockholders or Optionholders personally represented anything as to the accuracy of
the financial statements, signaling they were not in a position to know the veracity
of the statements. Further, Sparton does not plead any particularized facts about
Defendants’ roles in the Company or any of Defendants’ relationships with
management, other than that they are Stockholders and Optionholders and that
O’Neil is the Representative of the Stockholders and Optionholders. And Sparton
fails to allege any other facts to show that any of the Defendants had the authority to
prepare either the invoices or the financial statements or that they would be in a
66 Id. 67 Pl.’s Opp’n Br. 20. 68 Id.
25 position to know that these documents were falsely prepared.69 Thus, the Complaint
does not allege that Defendants knew that the invoices or financial statements were
overstated or improperly recorded. As a result, Sparton fails to allege a claim for
III. CONCLUSION For the foregoing reasons, I grant Defendants’ motion to dismiss in its
entirety. All of Sparton’s claims, except the Expenses Claim, are dismissed.
IT IS SO ORDERED.
69 Counsel for Sparton noted at oral argument that Spartan chose “not to conduct informal discovery on [its] own company at this point” to discover any of these facts. Oral Arg. Tr. 36.