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DE Corporate Law
Main image for Delaware Court of Chancery Dismisses Fraud Claim, Emphasizing Rule Against “Bootstrapping” Fraud and Contract Claims
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Delaware Court of Chancery Dismisses Fraud Claim, Emphasizing Rule Against “Bootstrapping” Fraud and Contract Claims

Delaware Law Update

11.1.2020

The Court of Chancery in this opinion ruled on the plaintiff’s motion to dismiss, which sought dismissal of the defendant’s counterclaims. The court ultimately granted in part and denied in part the plaintiff’s motion, emphasizing the well-known limitation that fraud claims cannot be based on contract claims, as that would amount to impermissible “bootstrapping.”

Case Background

The litigation arose from a transaction whereby the plaintiff, Transdev on Demand, Inc. (“Transdev”), sold its wholly owned (and underperforming) subsidiary, SuperShuttle International, Inc. (“SuperShuttle”), to defendant Blackstreet Investment Holdings, LLC (“Blackstreet”). As part of the transaction, the parties entered into a stock purchase agreement (the “SPA”) pursuant to which Transdev agreed to retain certain liabilities and to fund working capital, initially by providing an agreed-upon amount (initially approximately $18 million) to SuperShuttle for that purpose (the “Initial Funding Amount”). That amount would then be “trued up” post-closing. The SPA required Transdev to provide financial information before closing, and then to provide an “Estimated Closing Working Capital Statement,” to which Blackstreet could object.

At the closing of the sale, Transdev provided a summary to Blackstreet, estimating that the Initial Funding Amount should be decreased by $7,000. Once Blackstreet examined SuperShuttle’s books and records, Blackstreet concluded that Transdev’s estimate was inaccurate. Specifically, Blackstreet alleged that Transdev had materially overstated SuperShuttle’s assets and had materially understated SuperShuttle’s liabilities. Therefore, Blackstreet provided its own calculation of SuperShuttle’s estimated Closing Working Capital. Based on its calculations, Blackstreet asserted that the Initial Funding Amount actually needed to be increased by $7,485,177.

The “truing-up” process was the crux of the parties’ dispute. Specifically, the parties disagreed on the amount due to SuperShuttle from Transdev as working capital, and whether the SPA required that amount to be determined by an accountant or the court.

The Parties’ Claims

Transdev commenced the litigation, seeking declaratory relief, including a declaration that Blackstreet failed to timely object to the Estimated Closing Working Capital Statement, and thus had waived its right to object. It also sought a declaration that Blackstreet’s contractual rights had terminated and that the court should resolve any remaining legal issues regarding working capital.

Blackstreet asserted counterclaims against Transdev (i) seeking specific performance of a contractual provision requiring the parties to submit the dispute to an independent accountant, (ii) seeking a declaration that Transdev breached the contract in its calculation of working capital, and (iii) claiming that Transdev fraudulently induced Blackstreet to purchase SuperShuttle based on inaccuracies in its financial disclosures required under the SPA.

Transdev moved to dismiss Blackstreet’s counterclaims pursuant to Rule 12(b)(6) for failure to state a claim upon which relief may be granted. The court largely denied Transdev’s motion to dismiss, except with respect to Blackstreet’s counterclaim for fraudulent inducement. 

The Court Dismisses Blackstreet’s Fraud Claim

Blackstreet’s fraud allegations were based on the theory that Transdev promised to provide Blackstreet with GAAP-compliant financial statements, that Transdev made this promise to induce Blackstreet to purchase SuperShuttle, and that Transdev failed to keep its promise. Because Transdev’s duty to provide financial statements arose solely from the parties’ contract (the SPA), the court noted that such allegations only give rise to a contract claim, as there is no common-law duty requiring Transdev to provide financial statements. Because Blackstreet’s claim was premised on the theory that this contractual duty was breached, the court explained that Blackstreet “cannot also successfully argue that it was defrauded by Transdev’s failure to satisfy an obligation that arose exclusively from the terms of the SPA.”

The court further emphasized that this is the type of bootstrapping that the court does not accept: “If the financial statements were not compliant with the promises made in the SPA, Transdev has committed a contractual breach. But, having agreed to be bound by the contract, Blackstreet cannot litigate a tort action as a result of allegations of breach. That is, Blackstreet identifies no duty breached by Transdev, beyond those duties imposed by contract. In such a situation, Blackstreet is limited to its contractual remedies.”

Blackstreet also attempted to rely on a well-known case, Abry Partners V, L.P. v. F&W Acquisition LLC, for the proposition that knowingly false contractual representations may breach a tort duty as well as contractual duties. The court, however, distinguished Abry, finding it inapplicable because, in that case, the financial statements at issue were not simply inaccurate or misrepresented, but were alleged to have been manipulated to induce one of the parties in that case to enter into the subject contract. In contrast, Blackstreet’s claim alleged only that Transdev maintained and provided its books and records and financial documents in a manner that did not comply with the promises it made in the SPA. As noted by the court, that is a contract claim, assuming Blackstreet was damaged as a result of that conduct.

Blackstreet’s Remaining Claims for Declaratory Relief Survive Transdev’s Motion to Dismiss

Blackstreet also asserted a claim for specific performance of a contractual right to submit the working capital dispute to an independent accountant. Transdev, however, contended that this claim is identical to its own request for declaratory relief. While the court agreed that Transdev’s position was technically accurate, the court noted that “specific performance is an equitable remedy requiring a demonstration not only of a contractual right, but also that equity is compelled to act to enforce the right.” Thus, the court determined that Blackstreet’s request for specific performance was not redundant of Transdev’s claim. This opinion reflects the court’s close analysis of fraud claims, particularly when they are alleged alongside contract claims.

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Media item: Stephanie H. Dallaire
Stephanie H. Dallaire

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