Delaware Supreme Court Addresses Due Diligence “Willful Blindness,” Fraud, Anti-Reliance Provisions, and MAEs— Paragon Metals v. Smith

In Paragon Metals Holdings LLC v. Smith (July 1, 2026), the Delaware Supreme Court affirmed the Superior Court's holdings that the defendant (the "Seller"), who sold Paragon Metals (the "Company") to a private equity firm affiliate (the "Buyer"), made false representations and warranties in the parties' sale agreement (the "Agreement") and intended to defraud the buyer. The Supreme Court then reversed the lower court's holding that the Buyer's reliance on the Seller's representations and warranties was unjustified. The Supreme Court found justifiable reliance by the Buyer notwithstanding that the Buyer, during its due diligence process, encountered and allegedly largely ignored "red flags" of the falsity of the representations at issue.

Early in the Buyer's due diligence process, the Company learned from its key customers that they intended to scale back significantly their business with the Company. The Seller provided the Buyer with some limited information that would have put the Buyer on notice of the problem, and the Buyer did not robustly follow up on the information. Shortly before the closing, the key customers reduced their purchase orders with the Company, as a result of which the Company defaulted on the transaction financing, which led the Company to being on the verge of bankruptcy.

The Superior Court found, and the Supreme Court affirmed, that the Seller's representations relating to key customers and no-material adverse change therefore were false at closing; and that the Seller, as it deliberately concealed certain information from the Buyer, intended to defraud the Buyer. The Superior Court ruled that the Seller was not liable for fraud, however, because there were sufficient red flags relating to the customers' cutback in business such that the Buyer could and should have followed up but did not do so sufficiently. The Supreme Court reversed that holding, concluding that the Seller was responsible because the Buyer, although its due diligence process was imperfect, was not "willfully blind" to the truth and the Seller had intentionally concealed information from the Buyer.

Key Points

• Imperfect due diligence, without more, does not extinguish reliance on express contractual warranties-at least where the seller was intentionally hiding information. The Supreme Court concluded that the lower court improperly viewed the Buyer as having been "willfully blind" to the truth by ignoring red flags of potential falsity of the Seller's representations. The Supreme Court stressed that, even if the Buyer had been negligent in the due diligence process, (a) the Buyer did not take steps deliberately to avoid the truth and (b) the Seller had intentionally concealed the truth from the Buyer.
  
  
• The case is notable for the focus on justifiable reliance rather than falsity and intention to defraud. In most M&A-related fraud cases, the focus is on whether the representations at issue actually were false, and then, if so, whether the party making them intended to defraud the other party (i.e., acted with scienter). Notably, in Paragon, both courts concluded that the Seller's representations were false and that the Seller intended to defraud the Buyer. The judicial analysis centered on the issue of justifiable reliance-with the Superior Court viewing the Buyer as having had sufficient information from the Seller so as to be on notice of the problem and then making the choice not to follow up on it to discover the truth, but the Supreme Court viewing the Buyer as having had no obligation to conduct reasonable due diligence, particularly as the Seller had deliberately concealed information when the Buyer asked questions.
  
  
• A typical, one-sided anti-reliance provision does not create buyer rights or obligations. The Superior Court interpreted the anti-reliance provision as barring justifiable reliance by the Buyer because the provision stated that the Buyer had conducted and was relying on its own investigation of the Company (as well as the Seller's representations in the Agreement). The Supreme Court reversed, holding that a one-sided anti-reliance provision is intended to protect a seller against claims based on extra-contractual representations, and thus cannot be invoked (a) to bar justifiable reliance by a buyer on the seller's agreement misrepresentations, nor (b) to create an obligation that the buyer must conduct reasonable due diligence.
  
  
• The decision is also notable for the Supreme Court's reaffirming that common law fraud claims are subject to a "preponderance of the evidence" standard. While some other jurisdictions apply the more stringent "clear and convincing evidence" standard, the Supreme Court reaffirmed that (as it held last year in Sofregen Medical v. Allergan Sales) Delaware does not.
  
  
• The decision is also notable for indicating that "imminent bankruptcy" may qualify as a "material adverse effect." The Delaware courts have only ever once before found that an occurrence qualified as an MAE-in Akorn, which, notably, like Paragon, also involved what the court viewed as fraud by the seller. The decision underscores that Delaware courts, although generally highly disinclined to find that an MAE has occurred, may be somewhat more inclined to do so in a factual setting involving fraud.

Background. Paragon Metals (the "Company") manufactures automobile components, including bearing brackets for transmissions. In early 2019, the Buyer acquired the Company, for $100 million, from the Seller, who was the Company's founder and CEO. The Agreement included: (i) a typical "No-MAE" representation; (ii) a typical "Customers" representation, stating that the Seller had no knowledge of any intention by its key customers to change the rate at which they had been buying Company products nor the terms; and (iii) a typical "Anti-Reliance Provision," in which the Buyer acknowledged that it had conducted to its satisfaction an independent investigation of the Company and, in making the determination to proceed with the transaction, had relied on the results of that investigation and the Seller's representations expressly set forth in the Agreement.

Shortly after closing, two of the Company's three largest customers, "ZF" and "FCA," significantly decreased their orders with the Company, as a result of which the Buyer defaulted on the loan that financed the transaction and the Company was on the verge of bankruptcy. The Buyer infused an additional $37 million of equity into the Company to stabilize it. Shortly after closing, the Buyer learned that, while it was engaged in its due diligence process, ZF and FCA told the Seller that they intended to reduce their business with the Company significantly going forward. The Buyer sued the Seller, claiming common law fraud-specifically, that the No-MAE representation and the Customers representation were false at closing; that the Seller had acted with scienter in knowingly providing the false representations; and that the Buyer had justifiably relied on the representations when entering into the transaction.

The Superior Court entered a post-trial judgment in the Seller's favor. It found that the Seller made false representations in the Agreement and intended to defraud the Buyer-but that the Buyer did not justifiably rely on the misrepresentations, as the Seller had provided sufficient information for the Buyer to be on notice of the potential problem and the Buyer did not follow up to obtain more information. On appeal, the Supreme Court reversed the lower court's holding that the Buyer's reliance on the misrepresentations was unjustifiable. The Supreme Court held that the Buyer justifiably relied, notwithstanding that it had missed or ignored red flags in its due diligence process. Therefore, the Buyer established common law fraud and is entitled to damages.

Discussion

Buyer's due diligence process. The Buyer commenced its due diligence process in October 2018. The Seller gave the Buyers access to over 10,000 documents, including a five-year sale projection. The Buyer utilized professional legal, tax, insurance and accounting experts, spending about $1 million on the process.

Customers' reduced business with the Company. (i) In October 2018, ZF and FCA told the Seller that they intended to buy fewer bearing brackets from the Company going forward. The Seller updated the Company's five-year sale projection to reflect that information, and sent the updated projection to the Buyer. (ii) In November 2018, ZF sent a letter to the Seller (the "ZF Letter"), stating that ZF's need for bearing brackets would be sharply reduced and that the Company would no longer be its sole supplier of bearing brackets. (iii) Given these substantial changes, in December 2018, ZF and the Company signed an amendment to their agreement, to reflect the expected lower purchasing volume by ZF and certain changed deal terms. In reviewing the draft amendment ZF had proposed, the Company insisted that ZF remove the specific numbers showing the declined volume of orders. ZF agreed to do so when the Company promised ZF an unusually high rebate (the "Rebate"). The Agreement did not disclose the ZF Letter, the loss of sole supplier status for ZF, nor the Rebate.

"Red flags" in the due diligence process. The Supreme Court noted the following:

• In a draft document provided to the Buyer, the following language was striked-through: "Mike says there's a letter from ZF saying they're going to decrease their purchases." The Buyer asked the Seller about the striked-through language. The Seller (untruthfully) responded that ZF did not intend to withdraw business from the Company but was just switching its orders for brackets from one model number to another, with no effect on the overall purchase volume. The Buyer accepted that explanation, and did not ask to see the ZF Letter.
  
  
• For a meeting the Seller arranged for the Buyer to meet directly with ZF and FCA, the Buyer prepared a list of discussion topics, including the issue of an anticipated decrease in their purchase orders with the Company. At the meeting, however, the Buyer never asked for details about the expected decrease. The Buyer only asked whether ZF's business with the Company was "still good," and accepted ZF's response that it was still good although there would be "some noise in the volumes." Before and after that meeting, ZF pressed the Seller about sending it the Rebate; and, just after the meeting, the Seller arranged for an overseas affiliate to wire the Rebate to ZF so that the payment would not show on the Company's books (also, "curiously" the court stated, at this time the Seller threw away his cellphone).
  
  
• In a draft email, prepared by an employee of the Seller, listing items to be resolved before closing, the employee referenced the ZF Letter and added it as an attachment to the email. The Seller, when he reviewed the draft email before sending it to the Buyer, removed the ZF Letter as an attachment and added to the email a summary of the ZF Letter in a few bullet points (stating that the parties should "Review Anticipated Sales and ZFBB Cancellation Letter" and "FCA Volume only is cancelled with ZFBB"). The Buyer "did not read the email and therefore missed the critical reference to the ZF Letter."

Evidentiary standard for common law fraud in Delaware is a "preponderance of the evidence." The Supreme Court reaffirmed the lower court's finding of scienter by the Seller based on a "preponderance of the evidence." The Supreme Court rejected the Seller's contentions that there is "uncertainty" in the law on this point, and that the stricter standard should apply for fraud claims because they carry a "moral stigma of quasi-criminal wrongdoing."

Seller's scienter was established through "circumstantial evidence" of "conscious behavior." The Supreme Court affirmed the lower court's finding that the Seller acted with scienter (a required element for a fraud claim). The Supreme Court found the following circumstantial evidence "sufficient to support a finding that [the Seller] more likely than not intended to conceal the truth and induce [the Buyer] to enter the transactions through misrepresentations": (i) the Seller deleted the ZF Letter as an attachment to his email to the Buyer; (ii) the Seller insisted that ZF remove details concerning the declining volume from its general contract amendment; (iii) the Seller did not tell the Buyer that the Company had lost its sole supplier status with ZF; (iv) the Seller rerouted the rebate payment to ZF through a foreign affiliate to keep it off-the-books; (v) the Seller destroyed his company-issued cellphone "despite having no legal right to do so"; and (vi) the Seller knew, as early as November 2018, that the sales projection he sent to the Buyer in October 2018 was no longer accurate yet he never updated it.

Anti-Reliance Provision could not be invoked to protect Buyer. The Supreme Court reversed the lower court's holding that the Anti-Reliance Provision supported the Buyer's "justifiable reliance" on the Seller's misrepresentations in the Agreement. The lower court reasoned that the Provision (as is typical) stated that the Buyer was relying on those representations as well as its due own due diligence investigation. The Supreme Court, however, emphasized that the intended beneficiary of the Provision was the Seller, not the Buyer. The Supreme Court noted Johnson & Johnson, in which it held that "when a contract contains a one-sided anti-reliance clause disclaiming reliance by only one party, and the other party to the contract made no comparable promise[,] the clause cannot be invoked to bar the other party's post-closing claims for intentional extra-contractual fraud." The Supreme Court wrote: "In other words, sophisticated parties to a transaction may allocate the risk of extra-contractual fraud, but, in agreeing to a one-sided anti-reliance clause, only one party contractually promises that it did not rely upon statements outside the contract's four corners in deciding to sign the contract." Here, the Anti-Reliance Provision protected the Seller from potential fraud claims based on extra-contractual representations-and could not be used to establish justifiable reliance for an intra-contractual fraud claim against the Seller.

Anti-Reliance Provision did not create an obligation on Buyer to conduct reasonable due diligence. The Supreme Court reversed the lower court's holding that the Buyer's failure to conduct reasonable due diligence barred "justifiable reliance" on the Seller's misrepresentations. The Supreme Court agreed with the Buyer that the lower court erred by holding that the Anti-Reliance Provision implicitly imposed an obligation on the Buyer to conduct reasonable due diligence based on the provision stating that the Buyer had conducted to its satisfaction an investigation of the Company and was relying on that investigation. The Supreme Court stressed, again, that, in the Anti-Reliance Provision, the Buyer simply waived potential extra-contractual fraud claims against the Seller-"[the Buyer] intended to waive a right, rather than assume an obligation." Further, the Supreme Court stated, even if the Anti-reliance Provision could be interpreted as requiring the Buyer to perform "some due diligence," it did not impose any objective standard requiring that the due diligence be "reasonable." Rather, it states that the Buyer conducted an investigation "to its satisfaction," which indicates a subjective standard, and no other provision imposed a standard for the due diligence nor suggested that the Buyer would be held accountable should it fail to perform reasonable or effective due diligence. "Thus, even if [the Buyer]'s due diligence was insufficient, that fact does not prevent [the Buyer] from relying on [the Seller]'s warranties in the Agreement," the Supreme Court wrote.

Buyer was not "willfully blind" to the falsity of Seller's misrepresentations. The Supreme Court rejected the lower court's holding that the Buyer "should have known the truth" behind the Seller's false representations about the Customers' business with the Company and could not claim justifiable reliance on the misrepresentations because it had "remained willfully blind" to the truth. For "willful blindness," the Supreme Court stated, a party must (i) subjectively believe that there is a high probability that a fact exists and (ii) take deliberate actions to avoid learning of that fact. "In other words, a willfully blind party is one who takes deliberate actions to avoid confirming a high probability of wrongdoing and who can almost be said to have actually known the critical facts." The Supreme Court observed: "Nothing on the face of [the Seller's warranties] gave [the Buyer] reason to doubt the truth of the warranties." Importantly, "when [the Buyer] raised questions, [the Seller] concealed the truth." The Buyer's "trust" in the Seller, "while perhaps naïve, did not amount to deliberate action to avoid discovering the truth. Given the Seller's efforts to conceal the truth, he should not have been surprised when the Buyer did exactly what he intended-it justifiably relied on his false warranties in the Agreement."

Company's imminent risk of bankruptcy was an MAE. The Supreme Court affirmed the lower court's holding that the Seller's No MAE representation was false at closing based on the Company's then "imminent risk of bankruptcy," which occurred after the Buyer defaulted on the transaction financing due to the "extensive changes to [the Company]'s business with [the Customers]." The Seller did not challenge that finding on appeal, and the Supreme Court "therefore affirm[ed]" it.

Practice Points

• A buyer should conduct a robust due diligence process. Notwithstanding the Supreme Court's favorable ruling for the Buyer in Paragon, the case underscores the importance of a buyer conducting a robust due diligence process. While certainty cannot be attained through due diligence, a robust process provides assurance to the extent possible. A buyer should maintain a record of what due diligence was conducted, what documents were requested and reviewed, what questions were asked, and what responses were received.
  
  
• Due diligence should not be a passive process. Information provided to the buyer should not be blindly accepted as accurate; follow-up questions should be asked; backup data should be requested; utilizing one's own advisors and experts to doublecheck certain information should be considered. Where the company is private, there is a heightened challenge to verify information that is provided, particularly if the seller is not well-known to the buyer and/or does not have a significant reputation or track record.
  
  
• Information that a seller provides should be approached with an appropriate degree of skepticism. Information provided by a seller should not simply be accepted, particularly if there are red (or yellow) flags of possible falsity. If there are still questions or concerns after receiving seller's information or its responses to questions, they should be further pursued. If the seller's information or responses reference specific items (letters, emails, reports, etc.) that are relevant, those should be obtained and reviewed. Where the information is provided by persons with a duty to or acting on behalf of the seller, skepticism may be warranted on that basis alone, and, depending on the circumstances, a buyer should consider having the information reviewed by its own experts (see Edwards v. GigaAcquistions2 ("Cloudbreak") (Del. Ch. 2025)).
  
  
• A buyer should be mindful of potential negative legal consequences to conducting an inappropriately limited due diligence process. While Paragon highlights that a buyer does not have an obligation to the seller to conduct reasonable due diligence, and while business concerns are the paramount reasons for conducting a reasonable process, there can be negative legal consequences to conducting an insufficient process. For example, in Cloudbreak (2025), the court refused to toll the statute of limitations for fraud (which had only just expired) where it perceived that the party who allegedly received false information had engaged in a due diligence process that, in the court's view, was too limited. The court emphasized that the buyer could have conducted more expansive due diligence, rather than relying on the seller's oral statements and management presentations.
  
  
• Parties could consider drafting changes to a typical anti-reliance provision. Based on the Supreme Court's discussion in Paragon, parties might agree to reduce the seller's exposure to fraud by, for example, imposing an affirmative obligation on the buyer to conduct and rely on a reasonable due diligence process. For various reasons, however, the more likely route for a seller with negotiating leverage would be, instead, to narrow the scope of and expand the qualifiers to the representations and warranties it sets forth in the sale agreement.

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