Hiding the Ball Has Consequences: Delaware Supreme Court Reverses on Justifiable Reliance in M&A Fraud Claim

In Paragon Metals Holdings LLC v. Smith, No. 385, 2025 (Del. July 1, 2026), the Delaware Supreme Court held that a buyer could justifiably rely on representations in an acquisition agreement even though its due diligence failed to uncover information showing those representations were false. The decision confirms that a seller cannot avoid liability for knowingly false representations by arguing that better diligence by the buyer would have revealed the truth.

The Transaction and the Buyer’s Due Diligence

The case arose from the $100 million acquisition of Paragon Metals LLC (Paragon), an automotive components manufacturer, by two affiliates of a private equity firm (together, Stellex).

While the transaction was being negotiated, two of Paragon’s largest customers, ZF Transmissions Gray Court, LLC (ZF) and Fiat Chrysler Automobiles (FCA), told Paragon’s founder and then-CEO, Michael Smith, that they expected to reduce their future business with Paragon. ZF informed Smith that it would need fewer components because FCA was discontinuing certain transmission orders and that Paragon would lose its status as ZF’s sole supplier of bearing brackets. Smith also agreed to pay ZF a $300,000 rebate while insisting that ZF remove the lower purchasing volume from a contract amendment.

At the same time, Stellex was conducting due diligence on Paragon. During that process, however, it missed several “red flags” concerning the reduction in Paragon’s future business. Among other things, Stellex saw language in a draft document referring to a letter from ZF stating that ZF would decrease its purchases. When Stellex asked Smith about the reference, Smith explained that ZF would decrease orders for one product but increase orders for another, making the change effectively neutral. Stellex accepted that explanation without asking to see the underlying letter.

Stellex also met directly with ZF and FCA but did not uncover the full extent of the expected volume reductions. Approximately one month before closing, Stellex overlooked an email it received from Smith also referring to the ZF letter. Before sending the email, Smith had removed the letter from the attachments. Stellex never read the email and therefore did not see the reference to the letter.

Meanwhile, the acquisition agreement contained express warranties concerning Paragon’s customer relationships and business condition. Among other things, Smith warranted that he was not aware that specified customers would stop or decrease purchases or change the terms on which they did business with Paragon (the Customers Warranty). He also warranted that no event had occurred that would reasonably be expected to have a “material adverse effect” on the company (the MAE Warranty). Stellex, for its part, acknowledged that it had conducted its own independent investigation and, in deciding to proceed with the transaction, had relied on that investigation and the representations in the acquisition agreement.

Shortly after the transaction closed, Stellex learned of ZF’s and FCA’s expected purchase volume reductions. Stellex subsequently defaulted on the loan it used to finance the acquisition, bringing Paragon to the verge of bankruptcy, and invested another $37 million to stabilize the company.

The Superior Court Finds Reliance Unjustifiable

Stellex sued Smith in Delaware Superior Court for common law fraud, alleging that the Customers Warranty and the MAE Warranty were false and that Stellex had relied on those false warranties in acquiring Paragon. After trial, the Superior Court found that Smith’s contractual representations were false and that he intended to defraud Stellex. Despite those findings, the Superior Court entered judgment for Smith. It concluded that Stellex’s reliance on Smith’s false warranties was not justified because Stellex had encountered enough red flags that it “knew or should have known” the truth, and that Stellex was “willfully blind” because it failed to investigate those warning signs more effectively.

The Supreme Court Reverses on Justifiable Reliance

The Supreme Court affirmed the findings that Smith’s warranties were false and that he intended to defraud Stellex. However, it disagreed with the analysis of justifiable reliance in two respects and remanded the case for a determination of damages.

First, the Court rejected the conclusion that the acquisition agreement required Stellex to conduct objectively reasonable diligence. The agreement stated that Stellex had conducted an independent investigation “to its satisfaction.” The Court read that language as part of an anti-reliance provision limiting fraud claims based on statements outside the contract, not as a requirement that Stellex’s diligence meet an objective standard. Thus, even if Stellex’s diligence was imperfect, that did not prevent it from relying on Smith’s express contractual warranties.

Second, the Court considered whether Stellex’s missed red flags nonetheless made its reliance unreasonable. The Court drew an important distinction between failing to discover the truth and deliberately avoiding it. As the Court explained, a willfully blind party must “subjectively believe that there is a high probability that a fact exists” and “take deliberate actions to avoid learning of that fact.” The Court concluded that Stellex’s conduct did not meet that “stringent” standard.

When Stellex asked Smith about the potential decrease in ZF purchases, Smith gave an explanation that concealed the truth. Nor was the Court persuaded that the email sent to Stellex referring to the ZF letter put Stellex on sufficient notice, particularly because Smith said in that email that he would discuss the matter with Stellex later. Stellex’s reliance on Smith may have been “naïve,” the Court observed, but it was not a deliberate effort to avoid learning the truth.

Paragon offers practical guidance for both buyers and sellers in M&A transactions. For buyers, the decision reinforces the importance of thorough diligence and careful investigation of red flags, even though imperfect diligence will not insulate a seller from fraud liability. For sellers, it underscores that intentionally concealing information that contradicts an express contractual representation can create fraud exposure, even where the buyer had opportunities to discover the truth.

This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.