May 2006

Avoiding Liability for Securities Fraud: The Legal Significance of Integration (and Non-Reliance) Clauses Under State and Federal Law

by Leonard J. Feldman and Charles Ha

The Washington State Court of Appeals recently issued an important opinion regarding liability and the corresponding scope of relief under the Washington Securities Act (WSA). With regard to the scope of relief, the court held that the WSA authorizes an award of rescissionary relief (and not damages) where the stock at issue can be recovered by the buyer. See Helenius v. Send.com, Inc., 120 P.3d 954, 960 (Wash. Ct. App. 2005). With regard to liability, the court's opinion provides important guidance regarding the circumstances in which a party may immunize itself against misrepresentation claims under state or federal law by including a "non-reliance clause" in the underlying stock purchase agreement. This article discusses the court's opinion in Helenius, including its discussion of analogous federal law, and offers practical advice for parties who engage in such transactions.

To establish liability for securities fraud under the WSA, as under the federal securities statutes upon which the WSA was patterned, a plaintiff must establish that the defendant made a material misrepresentation and that the plaintiff reasonably relied on that misrepresentation in agreeing to enter into the securities transaction in question. See, e.g., Hines v. Data Line Sys., Inc., 114 Wn.2d 127, 134 (1990). Contracts for the sale of securities typically provide that the contract itself contain the entire understanding of the parties (what is commonly referred to as an "integration clause") and/or that the parties did not rely on any representations other than those contained in the contract in entering into the transaction (a "non-reliance" clause). The stock purchase agreement in Helenius included a provision that is both an integration clause (the first half of the sentence below) and a non-reliance clause (the second half):

This Agreement . . . sets forth the entire understanding of the parties hereto with respect to the matters provided for herein and supersedes all prior agreements, covenants, arrangements, understandings, communications, undertakings, representations or warranties, whether oral or written, by any officer, representative shareholder, agent or employee of any party.

Based on this provision, a group of defendants in Helenius argued that they could not be liable under the WSA for any misrepresentation that allegedly occurred prior to the effective date of the parties' agreement.

Most federal courts that have faced this issue under analogous federal securities statutes have held that a plaintiff cannot establish a claim under federal securities laws based on an alleged misrepresentation that is not set forth in the stock purchase agreement if that agreement includes an integration clause, a non-reliance clause, or some combination of the two. In Emergent Capital Inv. Management, LLC v. Stonepath Group, Inc., 343 F.3d 189 (2d Cir. 2003), for example, the parties' agreement expressly stated that the agreement, together with accompanying documents, "contain[ed] the entire understanding and agreement among the parties . . . and supersede[d] any prior understandings or agreements between or among any of them." Id. at 191. The court held that this clause was sufficient to preclude recovery under the federal securities act. Other courts have echoed that holding. See, e.g., Rissman v. Rissman, 213 F.3d 381 (7th Cir. 2000); Harsco Corp. v. Seguin, 91 F.3d 337 (2d Cir. 1996); One-O-One Enterprises, Inc v. Caruso, 848 F.2d 1283 (D.C. Cir. 1988).

In Helenius, however, the Washington Court of Appeals rejected this argument. This decision is significant because it runs counter to both Washington law — which enforced a similar provision to preclude liability in Stewart v. Estate of George Steiner, 122 Wn. App. 258 (2004) — and the majority of federal cases addressing this issue (as discussed above). The opinion also threatens to undermine the protection that such clauses provide to parties who enter into a stock purchase agreement and wish to avoid liability for statements that are not expressly set forth (often in the form of express representations) in the agreement itself.

Although the court's description of the facts in the Helenius appeal is lengthy and complex, its holding regarding the parties' agreement is relatively simple and straightforward. The court characterized the above-quoted provision in the parties' agreement as an integration clause and then distinguished its prior opinion in Stewart, which involved a clause that expressly stated that the parties had not relied on representations other than those contained in the contract. The court then held that various other considerations are also relevant to this analysis, including the sophistication of the plaintiff, the nature of the parties' relationship (business, personal, or fiduciary), access to relevant information and concealment of the fraud, whether the plaintiff initiated the stock transaction or sought to expedite the transaction, and the generality or specificity of the misrepresentations at issue. Helenius, 120 P.3d at 965-66 (citing Jackvony v. RIHT Financial Corp., 873 F.2d 411, 416 (1st Cir. 1989)). Based on these additional considerations, the court concluded that the parties' agreement did not preclude liability under the WSA.

While the Helenius decision raises questions with respect to the effectiveness of integration clauses and non-reliance clauses under the WSA, a number of important lessons can be gleaned from the court's opinion. First, the Court of Appeals clearly distinguished between integration clauses and non-reliance clauses, such as the clause at issue in Stewart, and implicitly held that non-reliance clauses are more effective than integration clauses in avoiding liability for statements that predate the parties' agreement. As such, parties who enter into such agreements should include an integration clause as well as a non-reliance clause. A good example of the latter can be found in Stewart: "The undersigned . . . has relied solely on the information contained in the [offering memorandum]  . . . [and] has not relied on any oral representation, warranty or information in connection with the offering of the Shares by the Company, or any officer, employee, agent, affiliate or subsidiary of the Company . . . ." 122 Wn. App. At 266.

Second, even in the context of non-reliance clauses, the Court of Appeals in Helenius also looked to the specificity of the parties' agreement, the sophistication of the parties, and the like. It cited with approval in this regard the Seventh Circuit's opinion in Rissman, where the stock purchase agreement in question included two separate non-reliance clauses. The first was a straightforward non-reliance clause that stated: "The parties further declare that they have not relied upon any representation of any party hereby released or of their attorneys, agents, or other representatives . . . ." Rissman, 213 F.3d at 383. The second was even more explicit and contained numerous representations regarding the plaintiff's non-reliance on representations not contained in the agreement itself, as well as representations regarding his capacity and understanding of the terms of the agreement itself:

(a) no promise or inducement for this Agreement has been made to him except as set forth herein; (b) this Agreement is executed by [the plaintiff] freely and voluntarily, and without reliance on any statement or representation by Purchaser, the Company, any of the Affiliates or . . . any of their attorneys or agents except as set forth herein; (c) he has read and fully understands this Agreement and the meaning of its provisions; (d) he is legally competent to enter into this Agreement and to accept full responsibility therefore; and (e) he has been advised to consult with counsel before entering into this Agreement and has had the opportunity to do so.

Id. Based in large part on these provisions, the Seventh Circuit held that the district court had properly granted summary judgment in favor of the defendants and explained that "[s]ecurities law does not permit a party to a stock transaction to disavow such representations — to say, in effect, 'I lied when I told you I wasn't relying on your prior statements' and then to seek damages for their contents." Id. In so holding, the court agreed with the First Circuit in Jackvony and the D.C. Circuit in One-O-One in concluding that "a written anti-reliance clause precludes any claim of deceit by prior representations." Id. at 383-84.

In summary, parties who execute a stock purchase agreement should consider including non-reliance clauses in addition to the integration clauses commonly found in such agreements. Moreover, the more specific these representations are, the more likely it is that a court will uphold these clauses and find that plaintiffs, as a matter of law, are precluded from relying on extraneous representations in support of their claims for securities fraud. 

Leonard J. Feldman and Charles Ha are attorneys in the Seattle office of Heller Ehrman LLP, whose practices focus on commercial litigation, including securities matters. Mr. Feldman was also counsel of record for several defendants in Helenius v. Send.com, Inc., which is discussed in detail in this article. The views expressed in this article are solely those of the authors.