G Corporate Finance Alert November 2001 Court Upholds Waiver of 10b-5 Claims in Stock Purchase By: John D. Hogoboom and Desiree K. Holzlein I n Landreth Timber Co. v. Landreth , 471 U.S. 681 Factual Background (1985), the Supreme Court ruled that the federal The plaintiff, AES Corp. ("AES"), acquired the securities laws applied to the sale of a business stock of a majority owned subsidiary from Dow structured as a stock sale. Since Landreth , there has Chemical ("Dow"). In connection with the proposed been a concern that sellers in a stock purchase could transaction, AES executed a confidentiality be subject to Rule 10b-5 claims notwithstanding the agreement stating that AES would not rely on any negotiation of specific, limited representations and information provided to it during its review of the warranties in the agreement. The recent case of AES affairs of the subsidiary other than information Corp. v. Dow Chemical Co. , Fed. Sec. L. Rep. (CCH) contained in specific representations and warranties ¶91,515, however, appears to offer sophisticated sellers included in a final purchase agreement. An offering who choose to structure a proposed transaction as a memorandum given to prospective purchasers stock rather than an asset sale a heightened degree of reiterated this provision, stating that only specific comfort with regard to limiting their exposure to representations and warranties made in a final potential Rule 10b-5 claims. agreement, if any, would have legal effect. It also contained cautionary disclosure that "statements, In AES , the United States District Court for the estimates, and projections" regarding future District of Delaware upheld contract provisions that performance were based on various assumptions that sought to limit a purchaser's ability to rely on might not prove to be accurate. The definitive representations and warranties not specifically set forth in agreement executed by the parties expressly stated the definitive acquisition documents. Applying a set of that except for the representations and warranties it factors developed by the Third Circuit to evaluate the contained, neither the parties nor any other person reasonableness of a plaintiff's reliance, the court had made any express or implied representations or determined that the plaintiff's alleged reliance on warranties on their behalf. It also provided that the representations and warranties not contained in those agreement and confidentiality agreement (and documents was unreasonable as a matter of law, certain unrelated agreements) constituted the entire eliminating a necessary element of the plaintiff's Rule 10b- agreement of the parties and superseded all prior 5 claim. The court further held that where the agreements or understandings with respect to the transaction at issue involved sophisticated parties transactions. The agreement included no negotiating at arm's length, Section 29(a) of the Securities representations or warranties regarding projections Exchange Act of 1934, as amended (the "Exchange Act"), for the subsidiary. which invalidates waivers of compliance with the Exchange Act and the rules thereunder, will not bar the Rule 10b-5 Claims enforcement of a waiver of reliance. The case highlights Subsequent to the purchase, AES filed suit that, if properly structured, potential Rule 10b-5 claims against Dow asserting that Dow had violated Rule can be eliminated in a stock purchase, at least in 10b-5 by misrepresenting the future prospects of the transactions involving sophisticated parties. subsidiary, directly causing AES's valuation of the This document is published by Lowenstein Sandler PC to keep clients and friends informed about current issues. It is intended to provide general information only. L Roseland, New Jersey Telephone 973.597.2500 65 Livingston Avenue www.lowenstein.com 07068-1791 Fax 973.597.2400
G subsidiary to be inflated by at least $70 million. Dow all relevant information, (3) AES did not allege the moved for summary judgment arguing that AES's existence of any long-term business or personal reliance on any representations not contained in the relationship, and (4) AES was a sophisticated party definitive agreement was unreasonable as a matter that was represented by outside counsel in the of law in light of the various provisions described transaction. above and the fact that none of the alleged misrepresentations were contained in the definitive In support of its motion for summary judgment, agreements. Dow relied on several decisions that upheld the enforceability of written disclaimers of reliance on Section 10(b) of the Exchange Act prohibits the representations not contained in the definitive use of manipulative and deceptive devices in agreements. In Rissman v. Rissman , 213 F.3d 381 (7th connection with the purchase or sale of a security. Cir. 2000), a former minority shareholder sued the Rule 10b-5 makes it unlawful: "(1) to employ any majority shareholder for securities fraud after the device, scheme, or artifice to defraud, (2) to make majority shareholder sold the company at a price any untrue statement of a material fact or to omit to much higher than that which the plaintiff had state a material fact necessary in order to make the received for his shares. The plaintiff alleged that the statements made, in the light of the circumstances defendant had "fraudulently induced him to sell his under which they were made, not misleading, or (3) stock by assuring him that [the company] would not to engage in any act, practice, or course of business be sold." The defendant, however, had refused to which operates or would operate as a fraud or deceit represent that he would not sell the company. upon any person, in connection with the purchase or Further, the plaintiff had represented in the stock sale sale of a security." To prove a violation of Rule 10b- that he would not rely on statements previously made 5, a plaintiff must show that the alleged violator: by the defendant. The Seventh Circuit granted "(1) made a misstatement or an omission of a summary judgment for the defendant, holding that "a material fact (2) with scienter (3) in connection written anti-reliance clause precludes any claim of with the purchase or sale of a security (4) upon deceit by prior representations." Id . at 384. which [p]laintiff reasonable relied and (5) that [p]laintiff's reliance was the proximate cause of In Harsco Corp. v. Segui , 91 F.3d 337 (2d Cir. [p]laintiff's injury." Semerenko v. Cendant Corp. , 223 1996), the Second Circuit held that a stock purchaser F.3d 165, 174 (3d Cir. 2000). could not maintain a Rule 10b-5 claim based on a representation not contained in the final agreement. Reasonableness of Reliance In Harsco , the parties' definitive agreement contained In the Third Circuit, the determination of fourteen pages of representations and warranties, a whether reliance is reasonable is based on five statement that the sellers did not make any factors set forth in Straub v. Vaisman & Co. , 540 F.2d representation or warranty other than those 591 (3d Cir. 1976): (1) the existence of a fiduciary specifically made in the written agreement itself and a relationship; (2) the plaintiff's opportunity to detect provision stating that the agreement contained the the fraud; (3) the plaintiff's level of sophistication; entire agreement of the parties. In holding for the (4) the existence of a longstanding business or defendant, the court stressed that the definitive personal relationship; and (5) access to the relevant agreement was a detailed writing that had been information. See id . at 598. Applying the Straub negotiated by sophisticated parties with the aid of factors, the AES court found that the plaintiff's advisors. reliance on representations not contained in the final transaction documents was unreasonable as a Similarly, in Jackvony v. Riht Fin. Corp. , 873 F.2d matter of law because: (1) Dow had no fiduciary 411 (1st Cir. 1989), the First Circuit held that the relationship with AES, (2) AES had ample plaintiff could not rely on statements made outside a opportunity to detect the alleged fraud and access to definitive purchase agreement and a related proxy
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