The Importance of Due Diligence

The Court, Seller, and Buyer all agree that the $10 million of cash in the dda accounts that Seller failed to sweep belonged to Seller; Yet the Buyer was awarded the funds.

---

In an unpublished Opinion, on March 29, 2021 Vice Chancellor Morgan T. Zurn authored a correct, yet tough opinion.

The action arose from a stock transfer whereby plaintiff Deluxe Entertainment Services, Inc. (“Seller”) sold all the outstanding shares of its wholly owned subsidiary, Deluxe Media Inc. (“Target”), to defendant DLX Acquisition Corporation (“Buyer”). 

At closing, approximately $10 million in cash remained in Target’s bank accounts. Seller alleged it failed to sweep those funds from Target before closing and Buyer does not dispute Seller had the right to sweep those funds before closing.

Seller brought three counts. Count I – Breach of SPA; Count II – Breach of the Implied Covenant of Good Faith and Fair Dealing; and Count III – Reformation of the SPA. 

Count I

Under the SPA, Seller agreed to sell to Buyer, and for Buyer to purchase and pay for all of Target’s shares in exchange for a cash payment. It is a general principle of corporate law that all assets and liabilities are transferred in the sale of a company effected by a sale of stock. When Seller agreed to sell Buyer all the Target Shares, it agreed to sell all the Target’s assets. Thus, by default, Target’s pre-closing assets and liabilities transferred with its shares.

Thus, the SPA presumed all Seller’s assets were included unless specifically excluded. Seller made no argument that cash was in any way excluded or subject to being clawed back. Seller does not contend that any of the express provisions of the SPA were breached. Seller Lost on Count I

Count II

In Count II, Seller argued that the implied covenant of good faith and fair dealing required Buyer to return the cash. 

The implied covenant of good faith and fair dealing inheres in every contract and requires a party in a contractual relationship to refrain from arbitrary or unreasonable conduct which has the effect of preventing the other party to the contract from receiving the fruits of the bargain.

The implied covenant cannot be used to circumvent the parties’ bargain, or to create a free-floating duty unattached to the underlying legal documents. 

An essential predicate for the application of the implied covenant is the existence of a “gap” in the relevant agreement. There is no gap in which the implied covenant can operate where the subject at issue is expressly covered by the contract, or where the contract is intentionally silent as to that subject. Seller Lost on Count II

Count III

Reformation is not an equitable license for a court to write a new contract at the invitation of a party who is unsatisfied with his or her side of the bargain; rather, it permits a court to reform a written contract that was intended to memorialize, but fails to comport with, the parties’ prior agreement.  A party seeking reformation admits that had they read the document more carefully, they would have noticed and corrected the mistake. Seller proffered no evidence that there was scrivener’s error in the SPA.

Rather, the “mistake” at issue was Seller’s failure to sweep the cash from Target’s bank account, separate and apart from the terms of the Purchase Agreement. Seller’s failure to sweep Target’s cash is an operations or accounting mistake, which is crucially distinguishable from a scrivener’s error in the underlying agreement itself that can be remedied by reformation. Seller’s mistake in its own preparation to perform the parties’ agreement cannot justify reforming that agreement. Seller bears the risk of that mistake. The court would not change the terms of the parties’ bargain to accommodate Seller’s error in preparing to perform under the agreement that reflects that bargain.

Seller Lost on Count III

Practice Pointer: Check and Double Check Your Preclosing Checklists