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ITW Global Investments Inc. v. American Industrial Partners Capital Fund IV, L.P.

Superior Court of Delaware

March 6, 2017

ITW GLOBAL INVESTMENTS INC., Plaintiff,
v.
AMERICAN INDUSTRIAL PARTNERS CAPITAL FUND IV, L.P.; AMERICAN INDUSTRIAL PARTNERS CAPITAL FUND IV (PARALLEL), L.P.; and AIPCF IV, LLC, Defendants.

         Upon Defendants' Motion for Summary Judgment: DENIED.

          Submitted: January 24, 2017

          P. Clarkson Collins, Esquire, Meghan A. Adams, Esquire, Morris James LLP, Richard C. Pepperman, Esquire (pro hac vice) (argued), William B. Monahan, Esquire (pro hac vice), C. Megan Bradley, Esquire (pro hac vice), Stephanie S. Heglund, Esquire (pro hac vice), Evan M. Mateer, Esquire (pro hac vice), Sullivan & Cromwell LLP, James H. Congdon, Esquire (pro hac vice), Sullivan & Cromwell LLP, Attorneys for Plaintiff.

          William D. Johnston, Esquire, Mary F. Dugan, Esquire, Young Conaway Stargatt & Taylor LLP, Lawrence Portnoy, Esquire (pro hac vice) (argued), Jillian Rennie Stillman, Esquire (pro hac vice), Shahira D. Ali, Esquire (pro hac vice), John M. Briggs, Esquire (pro hac vice), Davis Polk & Wardwell LLP, Peter D. Doyle, Esquire (pro hac vice), Jordan B. Leader, Esquire (pro hac vice), Seth D. Fier, Esquire (pro hac vice), Proskauer Rose LLP, John E. Roberts, Esquire (pro hac vice), Jinnie Reed, Esquire (pro hac vice), William D. Dalsen, Esquire (pro hac vice), Proskauer Rose LLP, International Place, Bo, Attorneys for Defendants.

          OPINION

          Jan R. Jurden President Judge.

         I. INTRODUCTION

         Before the Court is Defendants American Industrial Capital Fund IV, L.P., American Industrial Partners Capital Fund IC (Parallel), L.P., and AIPCF IV, LLC's (collectively, "AIP")[1] Motion for Summary Judgment.[2] AIP contends that it is entitled to summary judgment on ITW's fraudulent inducement claim.[3]

         This case arises from Plaintiff ITW Global Investments Inc.'s ("ITW") purchase of Brooks Instrument, LLC ("Brooks") from AIP (the "Transaction").[4]The Transaction was memorialized in the Securities Purchase and Sale Agreement ("SPSA"). According to ITW, AIP breached the SPSA by certifying that two allegedly false statements made in the SPSA were accurate: (1) all Material Contracts to which Brooks was a party had been disclosed in the SPSA; and (2) all financial statements had been prepared in accordance with GAAP.[5] ITW alleges that AIP's certification of these false statements, and AIP's involvement in a series of "sham sales" related to the false statements, fraudulently induced ITW to enter into the SPSA.

         In opposition, AIP asserts that any alleged misrepresentations in the SPSA were made by Brooks, not AIP, and therefore, ITW cannot prove that AIP had knowledge of the alleged misrepresentations. AIP further contends that ITW's release (the "NWC Release") in connection with a Net Working Capital adjustment bars ITW's fraudulent inducement claim.

         For the reasons discussed below, AIP's Motion for Summary Judgment is DENIED.

         II. BACKGROUND

         A. The Transaction

         In 2007, Defendant AIP, a private equity firm which buys underperforming companies, makes operational changes to improve their profitability and value, and then sells them for a profit, [6] acquired Brooks, which manufactures advanced flow, pressure, and vacuum measurement and control solutions, such as mass flow controllers ("MFCs").[7] AIP owned Brooks by way of AIP/BI Holdings, a holding company whose primary asset was Brooks.[8]

         In 2011, AIP sought to sell Brooks.[9] During the summer of 2011, AIP pitched Brooks to dozens of potential purchasers, including Plaintiff ITW, [10] a company specializing in the manufacture, sales, and service of industrial components and equipment.[11] On October 28, 2011, ITW submitted a $500 million bid to purchase Brooks.[12] ITW's bid was subject to certain conditions, including receipt of Brooks' financial statements from Fiscal Year 2011.[13] ITW also requested information regarding Brooks' "bookings" (orders received) and "backlog" (unshipped orders).[14]

         Brooks was expected to earn $13.5 million in revenue for October sales, [15]and $49 million in combined total revenue for October, November, and December 2011 sales.[16] In communicating with Brooks' CEO Clark Hale[17] and CFO Waqar Nasim[18] in late October, however, AIP's general partners Kim Marvin, John Becker, and Dino Cusumano, [19] Eric Baroyan (the AIP partner in charge of the efforts to sell Brooks), [20] and Paul Bamatter (the CFO of AIP and the Director of Brooks)[21] learned that Brooks was struggling to meet the $13.5 million October revenue projection.[22]

         As a result, AIP and Brooks reached out to another AIP subsidiary, Ichor, a semiconductor integrator that purchases supplies from Brooks to build larger systems for its customers.[23] David Shimmon, the CEO of Ichor, also served as a non-managing partner of AIP and the Chairman of Brooks' Board of Directors.[24]On October 31, 2011, after communication among the key players in AIP, Brooks, and Ichor, Ichor placed a $5 million order with Brooks[25] -which only drove up Brooks' October revenue to $10.8 million, leaving it $2.7 million shy of the October projection of $13.5 million.[26]

         AIP advised ITW of Brooks' October revenue on November 18, 2011, but represented that AIP still expected Brooks' total revenue for October, November, and December 2011 to be $49.3 million, given revised projections of $17 million in November revenue and $21.5 million in December revenue.[27] That same day, ITW responded by reducing its offer from $500 million to $425 million, [28]conditioned on Brooks' November revenue results.[29]

         Motivated to ensure that Brooks met its projected November revenue, AIP and Brooks communicated about a "Last Time Buy" sale involving Ichor.[30] Prior to 2011, Brooks had informed its customers that it planned to stop manufacturing various lines of gas-specific MFCs ("Legacy MFCs") and transition to its new line of MFCs ("GF MFCs").[31] Because of this transition, Brooks offered its customers the opportunity to make a Last Time Buy[32]

         In the summer of 2011, Applied Materials, Inc. ("AMAT"), a Brooks customer, expressed interest in placing a Last Time Buy order for the Legacy MFCs.[33] However, AMAT and Brooks encountered difficulties negotiating the terms of the Last Time Buy, and had not reached an agreement by November 2011.[34] As a result, in November 2011, Brooks once again turned to Ichor for help. Ichor agreed to take shipment of the Legacy MFCs, and resell the inventory to AMAT.[35] As AIP notes, "this arrangement was beneficial to Brooks because it could recognize revenue immediately upon shipment to Ichor."[36]

         In negotiating with Brooks, Ichor initially sought a right to return to Brooks any Legacy MFCs that AMAT did not ultimately purchase.[37] However, after Waqar Nasim advised Clark Hale that Brooks would not be permitted to recognize revenue if the written agreement included a right of return, [38] Brooks and Ichor excised the right of return from the written agreement.[39] The Last Time Buy Agreement was signed on December 2, 2011, but backdated to November 14, 20ll.[40] ITW argues that although the right of return was removed from the Last Time Buy Agreement, Brooks and Ichor shared the understanding that the right of return still existed based on their "working relationship."[41]

         In an effort to help Brooks meet its November revenue target, [42] Ichor ordered GF MFCs from Brooks.[43] According to ITW, David Shimmon agreed that Brooks could accelerate shipment of those products into November[44] if they were subject to a right of return or a rework provision.[45] In addition, in Fall 2011, Brooks sold $800, 000 worth of MFCs to Precision Flow Technologies ("PFT"), an Ichor subsidiary.[46] The agreement between Brooks and PFT included an express right of return.[47]

         Throughout late November 2011, AIP communicated with Brooks almost daily to monitor its sales and ensure Brooks was on track to meet the projected November revenue.[48] Much of AIP's communication specifically focused on the materialization of the Last Time Buy.[49] As a result of the Last Time Buy, Brooks recognized almost $1.5 million in revenue.[50] According to ITW, the Last Time Buy and the additional transactions with Ichor and PFT ultimately enabled Brooks to report $17.8 million in November revenue, [51] thereby exceeding its $17 million November revenue goal.[52]

         B. The SPSA

         On December 13, 2011, after receiving Brooks' November financial statements, ITW and AIP entered into the SPSA.[53] In the SPSA, ITW agreed to pay $425 million for Brooks, with a contingent $75 million "earn out" based on Brooks' performance in 2012.[54] Brooks represented in the SPSA that Brooks' financial statements for October and November 2011 "ha[d] been prepared in accordance with GAAP, "[55] and that Brooks "operated only in the ordinary course of business consistent with past practices" in October and November 2011.[56]

         In Schedule 2.17 of the SPSA, AIP listed each Material Contract to which Brooks was a party.[57] A Material Contract is defined in the SPSA as "a Contract involving the obligation of [Brooks] to deliver products or services for payment in excess of $250, 000 . . . other than purchase orders entered into in the ordinary course of business."[58] Paul Bamatter, the CFO of AIP and the Director of Brooks, signed the SPSA on behalf of both AIP and AIP/BI Holdings (Brooks).[59] The Last Time Buy was not disclosed in Schedule 2.17 of the SPSA.[60]

         ITW made the following representations in the SPSA: ITW did not rely on any statement made by AIP or Brooks "other than those representations expressly made" within the SPSA;[61] it had been permitted access to Brooks' management, facilities, books, and records during due diligence;[62] and it "is an informed and sophisticated purchaser and has engaged expert advisors, experienced in the evaluation and purchase of companies."[63]

         The SPSA includes an Exclusive Remedies provision which states:

From and after the Closing, the rights of the parties to indemnification relating to this Agreement or the transactions contemplated hereby shall be strictly limited to those contained in this Article VIII, and such indemnification rights be the sole and exclusive remedies of the parties subsequent to the Closing with respect to any matter in any way relating to this Agreement or arising in connection herewith. To the maximum extent permitted by law, the parties hereby waive all other rights and remedies with respect to any matter in any way relating to this Agreement or arising in connection herewith . . . except to the extent of fraud or willful misconduct by any Person[64]

         Notably here, the SPSA contains a carve-out that exempts fraud claims from the remedies prescribed in the Exclusive Remedies Provision.[65]

         Pursuant to the SPSA, closing was conditioned on, inter alia, the signing of Officer's Certificates by AIP certifying the accuracy of the representations and warranties in Articles II and III of the SPSA.[66] On January 3, 2012, Paul Bamatter and partner John Becker signed Officer's Certificates on behalf of AIP, which provide: "[T]he representations and warranties of [AIP/BI Holdings, Inc.] set forth in Section [] II of the [SPSA] are true and correct as of the Closing Date (other than representations and warranties that are made as of a particular date, which shall be true and correct as of such date.)."[67] The sale closed on January 3, 2012.[68]

         C. The Net Working Capital Adjustment

         The SPSA provides that the $425 million Purchase Price for Brooks would be adjusted based on the Net Working Capital ("NWC") at the time of Closing.[69]The target NWC was $42.4 million.[70] Section 1.4 of the SPSA provides for an initial adjustment of the Purchase Price on an estimation of Brooks' NWC made just prior to the Closing Date, [71] and Section 1.5 provides for a second NWC adjustment based on the NWC made after the Closing.[72] Section 1.5 allows ITW to dispute the NWC calculations, which ITW did as to both the Last Time Buy and PFT transactions.[73]

         The parties eventually settled on a final closing adjustment of $2, 495, 000 to be paid by AIP to ITW.[74] The NWC payment was memorialized in the NWC Release, dated June 8, 2012, which, inter alia, provides:

Buyers and Sellers' Representative each hereby agree that payment of the Final Closing Adjustment is made in complete and full satisfaction of all obligations of all parties pursuant to Sections 1.2 and 1.5 of the Agreement, and each party hereby completely and fully releases each of the other parties . . . from any and all claims, demands, actions, lawsuits, or causes of action of every kind, nature, or description, whether known or unknown, that now or hereafter exist as a result of or arising out of Sections 1.2 or 1.5 of the Agreement (the "Released Claims"). Each party hereto agrees not to sue or otherwise bring any action against any other party relating to the Released Claims, including, without limitation, pursuant to Article VIII of the Agreement.[75]

         In the months following ITW's acquisition of Brooks, Brooks did not perform as well as AIP had projected, or as ITW had expected.[76] After learning of allegedly false representations made in the SPSA, ITW filed suit against AIP for, inter alia, fraudulent inducement.[77]

         III. PARTIES' CONTENTIONS

         AIP argues it is entitled to summary judgment because Brooks, not AIP, made all of the alleged misrepresentations, and therefore, ITW cannot prove that AIP had knowledge of the alleged fraud.[78] AIP further argues that ITW must show that AIP knew about the alleged misrepresentations in the SPSA, and that a showing of reckless indifference to the truth is insufficient to prove the scienter element of a fraudulent inducement claim.[79] Finally, AIP asserts that ITW's release in connection with the NWC adjustment bars ITW's fraudulent inducement claim.[80]

         ITW counters that AIP is liable if it knew the representations in the SPSA were false or were made with reckless indifference to the truth, and that there are genuine issues of material fact with regard to AIP's state of mind that make this case inappropriate for disposition on summary judgment.[81] With regard to AIP's release argument, ITW responds that it has not released its fraudulent inducement claim because the NWC Release is limited to only the NWC adjustment.[82]

         IV. STANDARD OF REVIEW

         Summary judgment is warranted when "there is no genuine issue as to any material fact [] and the moving party is entitled to a judgment as a matter of law."[83] The Court must "view the facts of the record, including any reasonable hypotheses or inferences, in the light most favorable to the non-moving party.[84]" "Rule 56(c) mandates the entry of summary judgment against a party who fails to establish the existence of an element essential to that party's case."[85]

         With regard to AIP's release argument, summary judgment is inappropriate if the language in a release is "fairly susceptible [to] different interpretation[], " or where "there are conflicting factual inferences with regard to the scope of the release."[86] However, "[i]n construing a release, the intent of the parties as to its scope and effect are controlling, and the court will attempt to ascertain their intent from the overall language of the document."[87]

         V. DISCUSSION

         A. Fraudulent Inducement

         1. ITW must demonstrate that AIP had knowledge of the alleged misrepresentations.

         The elements of fraudulent inducement are: "1) a false statement or misrepresentation; 2) that the defendant knew was false or made with reckless indifference to the truth; 3) the statement induced the plaintiff to enter the agreement; 4) the plaintiffs reliance was reasonable; and 5) the plaintiff was injured as a result."[88] The knowledge that the statement was false, or made with reckless indifference to the truth, is commonly referred to as "scienter."[89]

         Under Delaware law, a private equity firm which sells one of its portfolio companies can be held liable for the portfolio company's misrepresentations in the sales agreement.[90] In ABRY Partners and Prairie Capital[91] which both involved the sale of a portfolio company by a parent, the Court of Chancery held that the plaintiff must make a showing of the seller's knowledge of, rather than reckless indifference to, the misrepresentations.[92]

         In ABRY Partners, a private equity firm (the "Buyer"), bought a portfolio company (the "Company") from another private equity firm (the "Seller").[93] The parties signed a Stock Purchase Agreement, wherein both the Seller and the Company made misrepresentations.[94] The Stock Purchase Agreement "carefully delineated]" which party-the Seller or the Company-actually made each representation and warranty therein.[95]

         The Stock Purchase Agreement in ABRY Partners contained a clause stating that the Company's financial statements "fairly present in all material respects the financial condition of the Company and the Company Subsidiaries at the dates therein indicated and the results of operations for the periods therein specified . . . [and] have been prepared in accordance with GAAP."[96] The Stock Purchase Agreement in ABRY Partners also contained an Exclusive Remedy Provision barring fraudulent representation claims against the Seller in favor of capped Indemnity Claims.[97] In addition, the Stock Purchase Agreement provided that the Closing of the transaction was conditioned on, inter alia, the submission of an Officer's Certificate.[98] The transaction closed after the Seller's representative signed the Officer's Certificate."[99]

         After the Closing, the Buyer in ABRY Partners uncovered numerous problems, prompting it to sue the Seller for fraudulent inducement.[100] The Buyer alleged that the Company's financial statements, upon which it had relied when negotiating the sale, "contained material misrepresentations and did not accurately portray the Company's financial condition."[101] More specifically, the Buyer alleged that the Company used a variety of improper methods to manipulate its reported earnings and overstate its revenues in a series of financial reports, thereby violating § 3.6 of the Stock Purchase Agreement.[102] In response, the Seller moved to dismiss the case for failure to state a claim.[103]

         The Court of Chancery held in ABRY Partners that while the Exclusive Remedies Provision would have ordinarily barred the Buyer's claim, Delaware's public policy-its "distaste for immunizing fraud"-permitted the Buyer to bring a fraudulent inducement claim against the Seller.[104] However, in an effort to balance the contract's plain language with Delaware's public policy, the Court of Chancery "resolved" that the Buyer was required to make a showing of the Seller's knowledge of the false statements, rather than merely showing that the statements were made with reckless disregard for the truth.[105]

         In ABRY Partners, the Court of Chancery refused to dismiss the case given the Buyer's well-pled allegations of facts and circumstances which, if proven, could support the conclusion "that the Seller was in a position to know of the falsity of the financial statements."[106] In particular, the Court of Chancery pointed to the signing of the Officer's Certificate, the Seller's "close contact with the Company's management on several occasions regarding the financials of the Company, " and their discussion of "such subjects as the preparation of projections to provide potential buyers, the Company's EBITDA, the Company's poor financial performance, and the attainment of certain financial targets" as factors which could support the conclusion that the Seller knew of the misrepresentations in the Stock Purchase Agreement.[107]

         In Prairie Capital, a private equity parent firm (the "Parent") sold a subsidiary company (the "Company") to a buyer (the "Buyer") who later sued the Parent for, inter alia, fraud.[108] In that case, the Stock Purchase Agreement included a carve-out which removed fraud claims from the purview of the Stock Purchase Agreement's otherwise all-encompassing indemnification provision.[109]The Prairie Capital transaction did not include Officer's Certificates.

         In Prairie Capital, the Court of Chancery, relying on ABRY Partners, held that the Buyer was required to show that the Parent knew of the Company's misrepresentations, even where there was a fraud carve-out[110]-as there is in the SPSA. In refusing to dismiss the fraud claim in Prairie Capital, the Court of Chancery pointed to several facts that, if proven, could "conceivably" support the conclusion that the Parent knew of the misrepresentations.[111] For example, the Court of Chancery considered that the Parent's directors:

participated in numerous conference calls regarding the preparation of the written . . . Presentation, made numerous revisions to, and ultimately approved, that document before its dissemination to [the Purchaser]. Indeed, [the Parent was] so intricately involved in the sales process that one or both of the [Parent's Directors] flew out to the Company's headquarters to rehearse the management presentation with [the Company's CEO and CFO] shortly before that presentation was given to [the Purchaser] . . . The [Parent's] directors oversaw the entire process and "affirmatively encouraged, assisted or approved the fraudulent scheme, including by approving or directing [the Company's CEO and CFO] to provide the false sales numbers for March 2012 to [the Purchaser], and then stood by silently while [the Purchaser] closed the transaction under false pretenses."[112]

         ITW argues that because Officer's Certificates were executed in the instant case, Prairie Capital is not on all fours with this case, and thus, Prairie Capital's knowledge requirement is inapplicable here.[113] This argument is unavailing. The execution of Officer's Certificates constitutes one factor, to be considered among many, that could support a showing of knowledge.[114] In ABRY Partners and Prairie Capital, the Court of Chancery looked at numerous facts and circumstances which could, if proven, support the conclusion that the parent firms knew of their subsidiaries' misrepresentations.

         2. Knowledge in fraud cases is often proven by circumstantial evidence.

         Because there often is no "smoking gun" in fraud cases that directly evidences knowledge, Delaware law provides that "intent can be inferred from circumstantial evidence."[115]

         In ABRY Partners, the Court of Chancery considered circumstantial evidence, including the execution of Officer's Certificates, as well as the motive and opportunity of the defendant to misrepresent facts, to reach its conclusion that summary judgment was not appropriate.[116] As noted by the Superior Court, the evidence in ABRY Partners "helped demonstrate a clear pattern of deception."[117]

         Here, there is a wealth of circumstantial evidence relating to knowledge, including, for example, numerous communications between directors of AIP and Brooks, [118] the execution of Officer's Certificates by Paul Bamatter and John Becker, transactions between Brooks and its customers, Ichor and PFT, that included rights of return, and AIP's motive and opportunity to misrepresent facts. This evidence could prompt a factfinder to conclude that AIP was involved in a "pattern of deception, " and/or that AIP had knowledge of the misrepresentations in the SPSA. It is clear from the record that there are genuine issues of material fact in dispute which must be determined by the finder of fact and are therefore inappropriate for disposition on summary judgment.

         3. The Officer's Certificates foreclose AIP's argument that because AIP disclaimed responsibility for the representations made by Brooks in Article II, AIP is not liable for those representations.

         AIP argues that because Brooks made the alleged misrepresentations in the SPSA, AIP cannot be held liable.[119] In support of this argument, AIP cites Abbott Laboratories v. Owens, [120] which involved the acquisition of a company (the "Company") by another company (the "Buyer"). In Abbott, the Company had an application pending before the FDA.[121] After the merger agreement was signed but before the closing, the Company received adverse news from the FDA, which was not, in turn, disclosed to the Buyer.[122] Officer's Certificates from the Company's directors certifying the veracity of statements in the merger agreement were thereafter delivered at the closing.[123]

         The Superior Court held in Abbott that because the adverse news was received after the merger agreement was signed, all of the representations in the merger agreement were true at the time the agreement was signed.[124] Thus, there were no misrepresentations at the time of signing that induced the transaction, and the Officer's Certificates did not certify any misrepresentations made by the acquired company.[125] The Court in Abbott specifically distinguished Abbotfs timeline from that in ABRY Partners, noting: "Unlike in [ABRYJ Partners, where the financial statements represented and warranted in the SPA were manipulated before the SPA was signed, in this case, all the alleged misrepresentations occurred after the Merger Agreement was signed."[126]

         Here, ITW alleges that the statements in the SPSA were false at the time the SPSA was signed, [127] and thus, Abbott is inapplicable. ATP has not provided, and the Court has not identified, any authority for the proposition that a parent is not responsible for its subsidiary's representations where the parent has executed Officer's Certificates certifying their veracity at the time the agreement was signed.

         4. Further genuine issues of material fact ...


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