On January 27, 2022, in Levy Family Investors, LLC v. Oars + Alps LLC the Delaware Court of Chancery (the Court) released a memorandum opinion providing clarity with regard to Delaware’s infamous “Anti-Bootstrapping Rule” (also referred to herein as the Rule). While the caselaw on the Anti-Bootstrapping Rule has been described as “muddled,” the Rule has generally been understood to prevent plaintiffs from “bootstrapping” a fraudulent misrepresentation claim onto a breach of contract claim. In its opinion, the Court provided guidance and ultimately ruled that, within certain scenarios, claims for fraud can be brought simultaneously with claims for breach of contract without running afoul of the Anti-Bootstrapping Rule.
The case relates to a series of transactions undertaken by the members of Oars + Alps LLC (Oars), including its founders (the “Founders”, and collectively with Oars, “Defendants”) and certain early investors and former convertible noteholders (Plaintiffs). The first transaction involved New Ventures PBL Holding LLC (New Ventures), an affiliate of S.C. Johnson & Son, Inc., acquiring approximately 75% of Oars’ outstanding membership interests in 2019, including substantial interests from the Founders. During the transaction process, which was led by the Founders, New Ventures demanded strict confidentiality with respect to the terms of the definitive transaction documents and denied Founders the right to share these documents with Plaintiffs (the Purchase Agreement). This created a conundrum for the Founders, who wanted to sell their membership interests but required the approval of the Plaintiffs, whose consent was required for sales of more than 5% of either of the Founders’ membership interests in Oars.
To accommodate the information gap, Defendants made certain representations to Plaintiffs within note cancellation agreements (NCAs), including that the Founders would receive $5.0815 per membership interest unit under the Purchase Agreement—the same price at which Plaintiffs would sell their own interests upon execution of the NCAs. Defendants also represented that, “[e]xcept with respect to the purchase price for [Oars] membership interests that the [Defendants were] transferring at Closing,” none of the sellers would receive any cash payments or valuable inducements in connection with the closing “…with respect to such membership interests” (emphasis added). In view of the Founders’ representations under the NCAs, Plaintiffs agreed to waive their blocking rights and allowed the first transaction to close.
A year after the closing, Plaintiffs read an article which reported that the sale of Oars also involved a second transaction. This second transaction, which was never directly disclosed to Plaintiffs by the Defendants, involved selling additional membership interests of Oars to New Ventures at a much higher per interest value than Plaintiffs had received under the first transaction. Under the second transaction, New Ventures made a capital contribution to Oars in exchange for an additional 436,867 membership interests at a price of $11.79 per unit. Notably, although the second transaction was included in the confidential Purchase Agreement, it was not disclosed to the Plaintiffs in the NCAs.
Plaintiffs subsequently brought several claims, including, among others (i) fraudulent inducement based on the representations made within the NCAs and (ii) breach of the NCAs. Defendants filed a motion for judgment on the pleadings as to all claims and in particular, moved to dismiss the claim of fraud on the basis that it was improperly “bootstrapped” onto the breach of contract claim.
First, the Court determined that Plaintiffs’ interpretation of the relevant representations within the NCAs were reasonable enough to move beyond the pleading stage. Then, the Court recognized that the status of Delaware caselaw regarding the Anti-Bootstrapping Rule was more than just “a little bit muddled,” and that Defendants’ argument that a plaintiff can avoid the Anti-Bootstrapping Rule “only by alleging conduct giving rise to the fraud that is separate and distinct from the breach of contract or that reflects a violation of an independent duty (separate from the contract),” was too limiting. Instead, the Court stated that a plaintiff could bring a fraud claim without violating the Anti-Bootstrapping Rule “by alleging facts that support an inference that the defendant knowingly made false representations in a contract on which plaintiff justifiably relied, and then breached that contact by violating the representations that were falsely made.” Moreover, the Court stated that in its view the Anti-Bootstrapping Rule stops plaintiffs from merely adding the term “fraudulently induced” to a complaint or alleging that a defendant never intended to comply specific terms when entering a contract and that a rule limiting plaintiffs from recovering for fraud solely because the same conduct also constituted breach of contract would offend Delaware public policy.
The Court went on to state that a fraud claim could proceed without violating the Anti-Bootstrapping Rule if: (1) the plaintiff alleges that the seller knowingly made false contractual representations; (2) damages for plaintiff’s fraud claim may be different from plaintiff’s breach of contract claim; (3) the conduct in question occurs prior to the execution of the contract and thus with the goal of inducing the plaintiff’s signature and willingness to close; or (4) the breach of contract claim is not well-pled such that there is no breach claim on which to “bootstrap” the fraud claim.
In the case at hand, the Court recognized that the first and second categories of exceptions to the Anti-Bootstrapping Rule would likely apply to Plaintiffs’ claims. First, even though there was significant overlap in the fraud and breach of contract claims, Plaintiffs’ claim of fraud in respect to the NCAs was separate and distinct from their breach of contract claim in that the Defendants knowingly made false representations in the NCAs when inducing Plaintiffs to enter into the same. Second, Plaintiffs sought compensatory or rescissory damages for the monetary losses resulting from the alleged fraud, but sought only compensatory damages for the alleged breach of contract. The difference in the two damage models was sufficient for the Court to find the second category of exceptions to be met. The Court, in finding the first and second categories met, allowed the fraud claim to move past the pleading stage without running afoul of the Anti-Bootstrapping Rule.
The Delaware Court of Chancery’s memorandum opinion provides much needed guidance on navigating Delaware’s implementation of the Anti-Bootstrapping Rule. Specifically, four categories are provided which will likely allow a claim of fraud to proceed without being barred by the Rule. Of course, due to Delaware’s influence in business and corporate law, it is possible that other states will look to this decision for guidance in refining their own Anti-Bootstrapping jurisprudence. Practitioners are well advised to consider whether their clients’ fraud claims brought in connection with breaches of contract are likely to survive scrutiny under Delaware’s newly articulated exceptions to the Rule.