PE Seller May Have Liability for Portfolio Company Concealing Steep Earnings Decline Post-Signing

Gail Weinstein is senior counsel, and Robert C. Schwenkel and Andrea Gede-Lange are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on their Fried Frank memorandum and is part of the Delaware law series; links to other posts in the series are available here.

Agspring v. NGP (July 30, 2020) involved the sale of a portfolio company, Agspring LLC, by one PE fund (the “Seller”) to another (the “Buyer”). At the pleading stage of litigation, the Delaware Court of Chancery found it reasonably conceivable that: (i) the Agspring officers deliberately concealed from the Buyer a steep decline in earnings that occurred before and after the signing and closing; and (ii) as a result of the decline, certain of the representations and warranties in the sale agreement and a related financing agreement were false when made. The court concluded that not only the Agspring officers but also the Seller may have known or been in a position to know that the representations were false when made; and that therefore they faced potential liability for fraud.

Key Points. The decision serves as a reminder that:

  • A PE-seller may have liability for its portfolio company’s fraudulent representations. When a PE fund sells a portfolio company, the fund can be liable for fraudulent representations made in the sale (or a related) agreement–even if the fund is not a party to the agreement.
  • A decline in earnings may implicate the accuracy of representations. A steep decline in earnings can support a reasonable inference that certain representations in a sale agreement (or related agreements) may have been false when made. In this case, at the pleading stage, the court found it reasonably conceivable that Agspring’s officers and the Seller were in a position to know that the steep decline in its earnings that began just before the sale agreement was signed may have (i) constituted a Material Adverse Effect and (ii) put the company on a course that would lead to a default under a Material Contract that occurred three years later.


In December 2015, around the midpoint of Agspring’s 2016 fiscal year, the Buyer and the Seller signed and closed a Purchase Agreement pursuant to which the Buyer acquired all of the membership interests in Agspring for $295 million (the “Transaction”); and certain investors (the “Investors”) provided $80 million in loans to Agspring pursuant to a Loan Agreement. The CEO and the President, respectively, of Agspring (the “Officers”) rolled over their equity (valued at $5.4 million); received cash payments totaling $7.5 million; and continued in their executive positions post-closing. Just before signing, the Seller shared with the Buyer Agspring’s forecast of FY 2016 EBITDA of $33 million (down from the $38 million forecast on which the Buyer had based its initial offer price of $325 million). At fiscal year-end, the Officers disclosed that actual EBITDA was $702,000. The Officers resigned shortly thereafter. The Buyer investigated and discovered that, just prior to signing, Agspring had “internally” revised its EBITDA forecast to $20 million. Post-closing, Agspring continued to struggle financially. In 2018, it defaulted on a material debt obligation. The Buyer and the Investors brought suit in 2019, alleging that the Officers and the Seller had fraudulently concealed from them Agspring’s dramatic decline in performance in the weeks leading up to and the months after signing and closing. They sought damages of $150 million, claiming that Agspring’s value at closing actually had been less than $145 million. Chancellor Bouchard rejected the motions to dismiss the fraud-related claims against the Officers and the Seller.


A PE-seller can be liable for fraudulent representations in an agreement even if it is not a party to the agreement. In most cases, a PE-seller of a portfolio company is not a party to the sale agreement. In Agspring, the Seller was a party to the sale agreement but not to the related financing agreement. The court found that the Seller faced potential liability for allegedly fraudulent representations in both agreements in light of the seller’s extensive involvement in Agspring’s business and the sale process. We note that a PE-seller should not face liability in the more typical context of claims being made for contractual breaches of representations rather than fraud (i.e., where it is not alleged that the false representations were made knowingly). Further, we note that the overall factual context as alleged in Agspring was egregious. The earnings decline was severe; it was allegedly deliberately concealed by the Officers (including by the President’s erasing information from his computer); and false reassurances were repeatedly provided by the Officers. We note that in Prairie Capital v. Double E (2015), another decision involving the sale of a portfolio company from one PE firm to another, Vice Chancellor Laster also held that the PE-seller was potentially liable for its portfolio company’s fraudulent representations in a sale agreement, even though in that case the seller was not a party to the agreement and the sale process had involved no direct communication between the seller and the buyer.

The court found it reasonably conceivable, based on the steep earnings decline, that representations in the Purchase Agreement and the Loan Agreement may have been false when made.

  • Material Contracts representation. In the Purchase Agreement, the Seller, the Officers and Agspring represented that, “to the knowledge of Agspring, no event has occurred or circumstance exists…[that may] result in a breach of or default under any Material Contract.” Three years after the closing, Agspring failed to make payments on a material debt obligation. The plaintiffs alleged that the defendants should have known before closing that the steep financial decline, together with the incurrence of the additional Transaction financing, would lead to the default. The defendants contended that no event had occurred before closing that would indicate that Agspring would violate a loan covenant 34 months later. The defendants also argued that representations about projections cannot be actionable for fraud because it is not “knowable” whether revenues will be achieved. The court found it reasonably conceivable that the effect of Agspring’s poor performance during the first six months of FY 2016 (known to the defendants and not disclosed), together with the incurrence of the Transaction financing (also known to them), “put [Agspring] on a downward spiral that would cause a default.” The court stated that, “although there [was] a forward-looking aspect to the [Agspring Material Contracts representation], the representation [was] rooted in Agspring’s financial condition at the closing based on historical events, e., events that had ‘occurred’ and were not only knowable, but allegedly known, at closing.”
  • Material Adverse Effect representation. In the Purchase Agreement, the Seller, the Officers and Agspring represented that “there has not been any…Material Adverse Effect” on Agspring since May 31, 2015. With little discussion, the court stated that the plaintiffs’ allegation that Agspring’s performance over the first half of its FY 2016 necessitated a reduction of approximately 47% of the forecasted earnings was “sufficient to support a reasonable inference of an [MAE] at the pleadings stage.”
  • Projections and Solvency representations. In the Loan Agreement, Agspring represented that its projections were prepared in good faith and that it was solvent. The court found it reasonably conceivable, based on the steep earnings decline, that these representations were false when made.

The court found that the Officers may have deliberately concealed material information. The plaintiffs alleged that, from the weeks leading up to the signing through seven months after the closing, the Officers made numerous statements “to perpetuate the myth” that the “artificially inflated forecast they provided” shortly before closing “remained achievable when they knew otherwise.” The Officers allegedly repeatedly provided false reassurances and in one case did not respond fully to the Buyer’s request for information. The court viewed the alleged destruction by Agspring’s President of information on his company computer as “standing out as a deliberate effort” to conceal information.

The court viewed the Seller as having been extensively involved in Agspring’s business and in the sale process. The plaintiffs’ allegations were “far more than sufficient,” the court stated, to support an inference that the Seller had been extensively involved in Agspring’s business and in the sale process such that it would have been “in a position to know when it signed the [Purchase Agreement] the knowable reality underlying the alleged falsity of the [Material Contracts and MAE representations] that was concealed from [the Buyer and the Investors], i.e., that Agspring’s financial results had declined dramatically over the prior six months necessitating material reductions to its forecast for the 2016 fiscal year, which severely threatened Agspring’s earnings and imperiled its ability to service its debt after the closing.” The Seller allegedly: (i) controlled Agspring; regularly received financial information from Agspring; and was contractually obligated to advise Agspring concerning financings and acquisitions; (ii) negotiated two price reductions directly with the Buyer (as a result of pre-signing earnings declines that had been disclosed to the Buyer); provided “specific feedback to improve Agspring’s consolidated financial statements”; and “encouraged Agspring employees to modify financial documents…so that [Agspring] would look more attractive to potential investors”; (iii) “understood that attaining a specific EBITDA was essential to the [Buyer’s] value proposition and to secure financing” for the Transaction and that “maintaining consistent financial projections and a positive outlook was key to getting the deal closed”; and (iv) “constantly communicated with [the Officers] during the sale process,” including “push[ing] [them] to close the deal as [Agspring]’s forecasts worsened, stating in November ‘need a close now,’ and calling, texting, and emailing [the Officers] constantly in December 2015.”

The statute of limitations on fraud claims may be tolled when officers concealed material information. The court ruled that, with respect to the Officers and the Seller, the statute of limitations was tolled under equitable doctrines given the alleged fraudulent concealment by the Officers, who were fiduciaries of Agspring.

Practice Points

  • A private equity fund selling a portfolio company should be mindful that the court generally may be skeptical that a PE-seller would not have known about a material change in its portfolio company and the concealment of that change from the buyer. Particularly in the context of an egregious alleged factual setting relating to the portfolio company’s concealment of information, a PE-seller may be held accountable for the company’s fraudulent misrepresentations in an agreement (even if the seller is not a party to the agreement). Notably, in Agspring (as well as Prairie Capital), the PE-seller allegedly knew about, participated in, and sanctioned (and, in Prairie Capital, even possibly orchestrated) the fraud. It is unclear to what extent the court might consider a PE fund to be potentially accountable for its portfolio company’s fraudulent misrepresentations based on allegations that fall short of these.
  • A seller must consider what to do when, during the sale process, projections (or other material information) provided to the buyer earlier in the sale process no longer reflects current expectations with respect to the business. Even when fraudulent conduct or falsity of an express representation in the sale agreement is not at issue, selling parties may come to have knowledge during the course of the sale process (especially if it is lengthy) that projections (or other information) provided to the buyer at an earlier stage may have become inaccurate. Any such material information generally should be provided to the buyer—even if the agreement does not expressly provide that the representations must be updated, even if the seller is not a party to the agreement, and even if there is no specific representation in the agreement that has become false. A seller should consider (with legal counsel) the appropriate timing, form, and extent of disclosure of this type of development. While such disclosure can lead to renegotiation of the price (or even potentially termination of the deal), it will mitigate the risk of fraud claims, as well as the risk of reputational damage (which could impede a firm’s ability to sell portfolio companies or otherwise effectively conduct business in the future).
  • Sellers may seek to mitigate the risk associated with post-closing fraud claims. Post-closing fraud claims span a continuum. In some cases, the claims are made by a buyer who was “duped” into agreeing to a transaction based on a seller’s false representations that were apparently knowingly made. In other cases, the claims may be made by a buyer who simply has “buyer’s remorse” and bases the claims on representations that turned out to have been false but were innocently (or possibly negligently) made. In addition to providing for “fraud carve-outs” to the sole remedies and non-reliance provisions, sellers may wish to consider seeking to include less common provisions (to the extent permissible under state law) that would contractually limit, for example, the parties against which fraud claims could be made, the timeframes for making them, the subject matters to which they could relate, and/or the responsibility for payment of the fees and expenses incurred in defending them unless the buyer prevails in the litigation.
  • Indemnification of portfolio company executives. Given the potential of liability for portfolio company executives for fraudulent misrepresentations in a sale process, indemnification provisions in the company’s charter and/or executive employment agreements should be reviewed to ensure that they reflect the parties’ intentions with respect to indemnification of executive officers therefor.
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