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Xu v. Heckmann Corp., C.A. No. 4637-CC (Del. Ch. Oct. 26, 2009) (Chandler, C.)

October 26, 2009

In this case, the Court of Chancery considered, among other things, whether breach of fiduciary duty counterclaims against the plaintiff, a former director of a Delaware corporation, were barred by a mutual release provision and whether the defendant could assert a fraudulent inducement defense to bar enforcement of an agreement between the parties.

The disputes at issue in Xu evolved out of the merger of China Water, a Chinese bottling company founded by the plaintiff Xu Hong Bin (“Xu”), into a subsidiary of Heckmann Corporation (“Heckmann”). When the merger closed, Xu continued as president of China Water and became a Heckmann director. As consideration for the merger, Xu received cash, the right to share in an additional contingent payment in cash or stock, and restricted Heckmann shares. At Xu’s direction, a portion of the restricted shares were transferred to Kotex Limited (“Kotex”), a corporation in which he was a co-owner, and placed in escrow. After the merger, Heckmann learned that China Water’s sales had plummeted and Xu provided an inadequate explanation for the decline. Thereafter, Heckmann and Xu entered into an escrow resolution and transition agreement (the "ERTA"), which, among other things: (i) required Xu to resign as president of China Water and as a Heckmann director; (ii) required Xu to sell a portion of Kotex’s escrowed shares back to Heckmann at a discount; (iii) contained a general release under which the parties released each other from any and all claims existing at the time of the ERTA (the “Release”); (iv) contained an integration provision that the ERTA is the sole agreement between the parties (the “Integration Clause”); and (v) contained an anti-reliance provision under which the parties agreed that they did not rely on any representations made outside the four corners of the ERTA (the “Anti-Reliance Clause”).

After learning of potentially fraudulent conduct by Xu, Heckmann refused to perform under the ERTA, and Xu brought suit for specific performance of the ERTA. Heckmann asserted various counterclaims, one of which alleged breach of fiduciary duty by Xu. Xu moved to dismiss the breach of duty counterclaim on the grounds that the Release barred any and all claims existing at the time of the ERTA, regardless of whether they were known to Heckmann at the time. Heckmann responded that Xu, as a director of Heckmann at the time, had a fiduciary obligation to disclose and fully inform Heckmann of all of the allegedly fraudulent activities he had committed, and that his alleged failure to do so rendered the ERTA voidable. The Court acknowledged the general rule that a fiduciary’s failure to disclose material facts relating to a mutual release of claims is sufficient to set aside the release. Nonetheless, the Court also noted that case law creates a general exception to that rule if a director negotiates a general release amid suspicions or allegations of fraud by the director. Under such circumstances, the mutual release is intended to settle those fraud claims, even if the full scope of the fraudulent conduct is unknown when the release is signed. Thus, the Court concluded that the pivotal question was whether Heckmann was generally aware of Xu’s potentially fraudulent conduct at the time the release was signed. Because it was unclear whether Heckmann had such knowledge, the Court denied Xu’s motion to dismiss the counterclaim for breach of fiduciary duty.

The Court also addressed Heckmann’s affirmative defense that the ERTA was unenforceable because Xu fraudulently induced Heckmann to sign it through alleged misrepresentations made both in the terms of the ERTA and unrelated to the ERTA. Applying New York law, which governed the ERTA, the Court held that Heckmann was barred from asserting a fraudulent inducement defense based upon alleged misrepresentations by Xu that Heckmann knew about when it signed the ERTA, as such a defense would be barred by the Release.

With respect to the alleged fraudulent misrepresentations that Xu made in the ERTA itself, the Court held that a defense to the enforcement of the Release as to those misrepresentations would survive the motion to dismiss. The ERTA only released fraud claims as of the date of the ERTA, and misrepresentations in the ERTA itself would be separate and distinct from the fraudulent misrepresentations that the ERTA released. The Court also held that the Anti-Reliance Clause and the Integration Clause barred a fraud in the inducement defense based on fraudulent misrepresentations made outside of the ERTA, but not misrepresentations purportedly made in the ERTA itself.

The full opinion is available here