Judge Medinilla’s recent opinion in Cytotheryx, Inc. v. Castle Creek Biosciences, Inc. is a reminder for practitioners to carefully consider whether an integration clause in a purchase agreement will be sufficient to bar extra-contractual misrepresentation claims. And although fraud claims arising out of M&A transactions often are brought against sellers, the decision also offers an example of how those claims can be brought against purchasers, particularly in transactions using stock consideration.
Sitting by designation as a Vice Chancellor of the Delaware Court of Chancery, Judge Medinilla denied a motion to dismiss claims for fraud and promissory estoppel brought by Cytotheryx, Inc. (“Cytotheryx”), the seller in a merger, against Castle Creek Biosciences, Inc. (“Castle Creek”), the buyer, and Paragon Biosciences, LLC (“Paragon”), the buyer’s private equity sponsor. The claims stem from Castle Creek’s refusal to redeem certain preferred stock paid to Cytotheryx as part of the merger consideration.
Pursuant to a merger agreement signed on October 28, 2021, Cytotheryx sold its majority interest in novavita thera, Inc. to Castle Creek for cash and Castle Creek preferred stock. The merger agreement included the following integration clause:
This Agreement, together with the Exhibits and Annexes hereto, and the Disclosure Letters and the other Transaction Documents, contains the entire understanding of the parties hereto with respect to the subject matter contained herein and supersedes all prior agreements and understandings, oral and written, with respect hereto.
The agreement did not separately include a so-called non-reliance clause, i.e., an express disclaimer of reliance on extra-contractual representations, or a representation by either party that it was relying only on the written representations and warranties in the purchase agreement.
The preferred stock that Cytotheryx received in the merger included a redemption right set forth in Castle Creek’s charter, which stated that upon request by the holders of the preferred stock, Castle Creek would redeem the shares “provided that such redemption does not then violate this Certificate of Incorporation or [Castle Creek’s] then existing governance documents or debt financing documents.” In fact, one such Castle Creek debt financing document, a February 2020 loan agreement, did not permit Castle Creek to redeem its equity securities.
On April 1, 2023, Cytotheryx demanded redemption of its preferred stock, but Castle Creek declined to redeem the shares because of the restriction in the loan agreement.
Cytotheryx sued for fraud and promissory estoppel, alleging that during negotiations, Castle Creek’s chief operating officer made a series of statements promising that Cytotheryx would be able to redeem the Castle Creek preferred stock if Castle Creek did not experience a liquidity event on or before March 31, 2023.
Cytotheryx alleged that, among other statements, a statement by Castle Creek’s COO that “Castle Creek had its lender’s approval” fraudulently misled Cytotheryx into believing that a future redemption of its preferred shares had been approved. Castle Creek argued that that statement related to the lender’s approval of the merger agreement only. The court rejected Castle Creek’s argument and held that at the pleadings stage, that statement reasonably could be interpreted as a representation by Castle Creek that its lender had approved not only the 2021 merger agreement but also a future 2023 redemption of the preferred shares.
The court held that the integration clause alone was insufficient to bar Cytotheryx’s fraud claim in part because the statement that lender approval had been obtained was not actually contradicted by the terms of the merger agreement. And the court noted that the merger agreement did not include an express disclaimer of reliance on any extra-contractual statements made by Castle Creek representatives.[1] Such non-reliance provisions are enforceable under Delaware law if they are explicit and unambiguous. See Prairie Cap. III, L.P. v. Double E Holding Corp., 132 A.3d 35, 50 (Del. Ch. 2015).
The Cytotheryx case illustrates the potential for wide-ranging interpretations of casual remarks inevitably made during negotiations. A disclaimer of reliance on extra-contractual statements can limit the effect of those remarks, and in this case, such a provision may well have prevented this litigation.
Courts have grappled for years with the balance between freedom of contract and the public policy against permitting parties to disclaim their own fraud by agreement, but even courts willing to enforce disclaimers of reliance generally require clear and express language.
ENDNOTE
[1] The court also noted that the merger agreement expressly preserved fraud claims based on or arising out of the transaction documents.
This post comes to us from Sidley Austin LLP. It is based on the firm’s blogpost, “Court of Chancery Opinion Highlights the Importance of Clear Integration and Non-Reliance Provisions in M&A Agreements.” dated November 20, 2024, and available here.