Chancery Court Finds No “Gap” to be Filled, No Implied Covenant Claim in Earn-Out Dispute
By Nick Froio and Lauren Garraux
Chancery Court grants defendant’s motion to dismiss alternative claims of breach of the implied covenant of good faith and fair dealing, fraudulent inducement and negligent misrepresentation in earn-out dispute, holding that merger agreement set the standard to determine whether non-payment of earn-out was improper.
Fortis Advisors LLC v. Dialog Semiconductor PLC, C.A. No. 9522-CB (January 30, 2015) involves a dispute over whether earn-out payments are owed to the former equityholders of iWatt, Inc. (“iWatt”) pursuant to an Agreement and Plan of Merger dated as of July 1, 2013 (the “Merger Agreement”) whereby Dialog Semiconductor PLC (“Dialog”) acquired iWatt. Under the Merger Agreement, Dialog was to pay earn-out payments of up to $35 million depending on the post-merger revenues of Dialog’s Power Conversion Business Group, of which iWatt became a part post-closing. In addition, the terms of the Merger Agreement required that Dialog use its “commercially reasonable best efforts” to achieve and pay the earn-out payments in full. Revenues, however, fell short of the threshold amount to trigger the earn-out payments.
Plaintiff Fortis Advisors, LLC (“Fortis”), the representative of the former equityholders of iWatt, filed suit against Dialog relating to the earn-out payments and, in its second amended complaint (the “Complaint”), alleged claims against Dialog for (i) breach of the Merger Agreement; (ii) specific performance; (iii) breach of the implied covenant of good faith and fair dealing; (iv) fraudulent inducement; and (v) negligent misrepresentation. Dialog moved to dismiss claims (iii), (iv) and (v) for failure to state claims for relief pursuant to Court of Chancery Rule 12(b)(6) and, for claims (iv) and (v), for failure to satisfy the particularity requirement of Court of Chancery Rule 9(b). The Court granted Dialog’s motion.
With respect to Fortis’ claim for breach of the implied covenant of good faith and fair dealing, the Court explained that the covenant “only applies where a contract lacks specific language governing an issue and the obligation the court is asked to imply advances, and does not contradict, the purposes reflected in the express language of the contract.” In dismissing Fortis’ claim the Court found that the Merger Agreement already set the contractual standard (i.e., to use commercially reasonable best efforts) by which to evaluate whether Dialog’s failure to achieve and pay the earn-out payments was improper, and that Fortis identified no “gap” in the Merger Agreement to be filled by implying terms through the implied covenant. Indeed, Fortis expressly acknowledged that it “does not believe any” gaps exist, but sought to maintain the implied covenant claim as an alternative legal theory in case the Court may disagree in the future, an approach to pleading which the Court rejected.
The Court further held that Fortis’ Complaint failed to plead fraudulent inducement with particularity, as is required under Court of Chancery Court Rule 9(b). While Fortis’ Complaint alleged that Dialog made four materially false statements during the parties’ negotiations to induce iWatt to enter into the Merger Agreement, Fortis did not allege when the alleged misrepresentations were made, by and to whom they were made and where or by what means they were made, thereby failing to apprise Dialog of “sufficient information concerning the circumstances of the allege fraud” and, as a result, failing to satisfy the particularity requirement of Rule 9(b).
Finally, the Court held that Fortis’ claim for negligent misrepresentation — which was based on the same allegations cited in support of its fraudulent inducement claim — should be dismissed for two reasons. First, like its fraudulent inducement claim, Fortis failed to plead the elements of negligent misrepresentation — which requires the plaintiff to demonstrate all of the elements of common law fraud with the exception that the misrepresentation was made knowingly or recklessly — with requisite particularity. Second, and independently, the Court held that Fortis failed to allege facts to establish one of the two circumstances in which a negligent misrepresentation claim can lie under Delaware law, that is, in the context of a fiduciary or other special relationship, or where there is justification for a remedy that only equity can afford. To the contrary, the dispute arose from a transaction that ostensibly was a product of an arms-length negotiation between sophisticated parties and Fortis sought only damages — and not any form of equitable relief — with respect to its negligent misrepresentation claim.
For these reasons, the Court granted Dialog’s motion to dismiss Fortis’ claims for breach of the implied duty of good faith and fair dealing, fraudulent inducement and negligent misrepresentation.