In a recent case captioned Heritage Handoff Holdings, LLC, v. Fontanella, Brown Rudnick’s M&A litigation team obtained a trial victory in Federal Court in Delaware on behalf of a Buyer of a company that supplied steel forgings to Tier 1 automotive suppliers. In Heritage, the Court found that the Seller committed federal securities fraud and breach of contract in connection with certain representations that the Seller made concerning the company’s top customers and awarded the Buyer substantial damages that were the equivalent of over 40% of the purchase price.
The Court’s decision in Heritage highlights the importance of carefully considering and negotiating for key representations to be included as “fundamental” or “core” representations when entering into an acquisition.
Most acquisition agreements contain a subset of representations and warranties referred to as core or fundamental representations (“Core Reps”), which often include: organization and standing, capital structure, powers and authorities, and title. The designation of a representation as “Core” or “Fundamental” is significant because Core Reps are often carved-out of any caps or limits to a Buyer’s ability to obtain indemnification for other, non-core representations. Core Reps may also be subject to a longer, sometimes indefinite, survival period for the purposes of asserting an indemnity claim.
In Heritage, the Buyer negotiated for the Seller’s representation concerning the company’s customers to be designated as a Core Rep given the company’s high customer concentration in a few specific customers. The Court afforded significant weight to the fact that the Buyer’s claims arose out of the breach of a Core Rep, finding that the Buyer “made it clear to [Seller] that the customer relations issue was critical by including [it] as a ‘core rep.’ A failure of a ‘core rep’ is so serious that it causes a deal to fall apart.” Moreover, because the Core Reps were carved out from the indemnification regime in the agreement, it permitted the Buyer to obtain damages in excess of the indemnification cap established for other, non-core representations.
As a result, the benefit to the Buyer of including the customer representation as a Core Rep was two-fold: it demonstrated to the Court the importance of the customer relationships to the overall value of the business, and it uncapped the liability of the Seller for any breach of those representations.
In sum, Buyers should think beyond the traditional “Core” or “Fundamental” representations and carefully consider including other representations and warranties that are important to the value and success of the business, such as key personnel, key facilities, key contracts, or key equipment. In addition to conducting thorough diligence into these issues, Buyers should consider including these critical representations as Core Reps in the ultimate transaction agreement to more fully protect the investment.
For more information on pursuing or defending post-closing claims, please contact the authors.