Confidentiality Agreements: Delaware Courts Remind Us Why They ...

Confidentiality Agreements: Delaware Courts Remind Us Why They Matter
Rhona E. Shwaid and Timothy Billion of Fredrikson & Byron, P.A.
Typically, one of the first steps in negotiating any transaction is the entry into a
confidentiality agreement between the potential buyer and the seller. Because the parties
are often eager to move forward with the negotiation process, the importance of this step
can sometimes be overlooked. Two recent Delaware cases serve as good reminders that the
terms of confidentiality agreements matter and can have real-life consequences that are
worth considering before parties sign.
Reminder #1: Make Sure Confidential Information Is Used Only for the “Purpose”
Most confidentiality agreements contain a “use restriction,” which is a provision that limits
the potential buyer’s ability to use the confidential information disclosed to it by the seller.
Typically buyers are permitted to use the confidential information of the seller solely for the
purpose of “evaluating a transaction between the parties.”
A similar provision was at issue in a recent highprofile case in Delaware. For almost a
decade, Martin Marietta Materials, Inc. (Martin) and Vulcan Materials Co. (Vulcan), strategic
competitors in the construction aggregates industry, had been considering the idea of
combining. In May 2010, the parties became more serious about pursuing a transaction and
entered into a confidentiality agreement. The confidentiality agreement did not include a
“standstill provision” (a provision that explicitly precludes the buyer from engaging in a
takeover bid for a certain period of time), but did contain a use restriction similar to the one
described above.
In late 2011, although Martin became very enthusiastic about acquiring Vulcan, Vulcan was
not in favor of the acquisition and negotiations stalled. Instead of walking away, in
December 2011, Martin made an unsolicited exchange offer and began a proxy contest to
replace four of Vulcan’s directors at the next annual meeting. Martin relied in part on the
confidential information disclosed by Vulcan in formulating its bid.
Vulcan sued to enjoin Martin’s takeover effort. Vulcan argued that the use restriction did not
permit Marin to use the confidential information for a hostile takeover bid; rather, it argued
that the permitted use of the information was limited to negotiating a friendly business
combination. The Delaware Court of Chancery agreed with Vulcan on this point and cited a
Canadian case, Certcom Corp. v. Research in Motion Ltd., (2009) 94 O.R. 3d 511 (Can. Ont.
Sup. Ct. J.), for the premise that a transaction “between the parties” does not include a
hostile takeover bid. Consequently, the Court enjoined Martin’s efforts to acquire Vulcan for
a period of time.
This case reminds us that if a company enters into a confidentiality agreement in the course
of evaluating a potential transaction, its employees and representatives should take care
not to use the confidential information disclosed during the course of due diligence for any
purpose other than evaluating a friendly transaction with the other party. In addition,
decisionmakers should be aware and take into account that once a confidentiality

agreement is entered into with the potential target, the company’s flexibility to engage in a
hostile takeover bid of the target at a later time may be greatly diminished.
Reminder #2: A Seller Might Lie During Due Diligence and the Buyer Probably
Can’t Do Much About It
Another common provision in confidentiality agreements is a non-reliance clause. This type
of clause typically states that a buyer may not rely on the completeness or accuracy of any
information provided by the seller during due diligence, and that no sale contract exists
between the buyer and the seller unless and until the parties enter into a definitive
agreement. What happens when a seller is not completely forthcoming with a buyer during
due diligence? Does the buyer have any recourse?
The Delaware courts recently addressed these questions. In the case RAA Management LLC
v. Savage Sports Holdings, Inc., Del., No. 577, 2011 (decided May 18, 2012), Savage
approached RAA to discuss a possible merger and the parties entered into a confidentiality
agreement. The agreement stated that Savage made no representations about the accuracy
or completeness of any information it provided to RAA, and that Savage would not be liable
to RAA based on RAA’s reliance on such information, unless Savage breached any
representations or warranties made in a later sale agreement. Additionally, RAA waived any
claims against Savage relating to the potential transaction unless and until the parties
entered into a sale agreement.
At the beginning of the discussions between Savage and RAA, Savage stated that there
were “no significant unrecorded liabilities or claims against Savage.” However, during RAA’s
due diligence process, Savage disclosed three major liabilities, which ultimately caused RAA
to abandon the transaction. RAA sued, alleging that, had it known of those liabilities at the
outset, it never would have pursued the negotiations and that because Savage had
knowingly covered up the liabilities earlier in the process, Savage should be liable for the
$1.2 million in costs that RAA incurred in performing its due diligence.
The Delaware court dismissed the complaint based on the nonreliance and waiver clauses.
On appeal, RAA argued that the nonreliance clause barred claims based on negligence or
mistake, but should not be extended to cover fraudulent or intentional misrepresentations.
Additionally, RAA argued that the Court should not enforce the nonreliance clause on policy
grounds because such a rule would give sellers an incentive to lie during the initial stages of
a transaction.
The Delaware Supreme Court rejected RAA’s arguments, finding that the language of the
agreement made no distinction between negligence and fraud, and that Delaware’s public
policy favors enforcing written nonreliance clauses. The Court noted that, at the time of the
agreement, both parties knew how nonreliance clauses had been interpreted by Delaware
courts and that RAA could not escape the terms it agreed to in its written agreement.
The RAA case serves to remind us that, while due diligence is a tool designed to help buyers
evaluate a possible transaction, buyers should not rely on statements or materials provided
by a seller during due diligence. Many confidentiality agreements preserve the seller’s ability
to limit its liability with respect to the quantity, quality, and timing of disclosures made
during the due diligence process, perhaps even in the case where the seller makes
fraudulent or misleading statements.

If a buyer uncovers unknown liabilities during due diligence, it will probably not be able to
recover the expenses it incurred in order to make that discovery. However, the buyer may
be able to limit its exposure to those liabilities by adequately allocating risk in the definitive
agreement, which will be binding upon the seller. If a buyer finds that the seller’s actions or
omissions are particularly egregious during due diligence, its ultimate remedy may be to
walk away from the deal. Although this may seem like a disappointing result at the time, in
the end, it means that the due diligence process worked.
Timothy Billion was a 2012 Summer Associate.
Rhona E. Shwaid, rshwaid@fredlaw.com
Rhona is a shareholder in Fredrikson & Byron’s Mergers & Acquisitions and Life Sciences
Groups, and is Co-Chair of the Commercial Law Practice Group.
Rhona represents private and publicly-held corporations as both buyers and sellers in a
variety of corporate transactions, such as mergers, stock purchases, asset purchases,
divestitures, minority investments and other strategic arrangements. In addition to
“healthy” M&A deals, she has experience with M&A deals involving distressed companies.
She regularly assists clients with a variety of commercial contracts, including supply and
manufacturing agreements, distribution agreements, services agreements, development
agreements and other arrangements that are critical for the smooth exchange of goods and
services between businesses.
Full Bio (http://www.fredlaw.com/bios/attorneys/shwaidrhona/)
Fredrikson & Byron, P.A.
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Material in this work is for general educational purposes only, and should not be construed
as legal advice or legal opinion on any specific facts or circumstances, and reflects personal
views of the authors and not necessarily those of their firm or any of its clients. For legal
advice, please consult your personal lawyer or other appropriate professional. Reproduced
with permission from Fredrikson & Byron, P.A.. This work reflects the law at the time of
writing in August 2012.