NetApp, Inc. v. Albert E. Cinelli ( 2023 )

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
NETAPP, INC., )
)
Plaintiff, )
)
)
v. ) C.A. No. 2020-1000-LWW
)
ALBERT E. CINELLI, AL.E.C )
HOLDING CORP., AEC CAPITAL )
CORPORATION, THE ALBERT E. )
CINELLI AND SHARON A. CINELLI )
2014 REVOCABLE TRUST, JOHN )
CINELLI, JANET CINELLI, DAVID )
GIBSON, GRANT TERRELL and )
KELSEY MACLENNAN, )
)
Defendants.
MEMORANDUM OPINION
Date Submitted: April 21, 2023
Date Decided: August 2, 2023
A. Thompson Bayliss, Matthew L. Miller, Joseph A. Sparco, Peter C. Cirka &
Anthony R. Sarna, ABRAMS & BAYLISS LLP, Wilmington, Delaware; Counsel
for Plaintiff NetApp, Inc.
Robert A. Penza, Stephen J. Kraftschik & Christina B. Vavala, POLSINELLI PC,
Wilmington, Delaware; Robert V. Spake, Jr., POLSINELLI PC, Kansas City,
Missouri; Britton St. Onge, POLSINELLI PC, St. Louis, Missouri; Counsel for
Defendants Albert E. Cinelli, AL.E.C Holding Corp., AEC Capital Corporation, The
Albert E. Cinelli and Sharon A. Cinelli 2014 Revocable Trust, John Cinelli, Janet
Cinelli, David Gibson, Grant Terrell, and Kelsey MacLennan
WILL, Vice Chancellor
“Let the buyer beware” is a common legal maxim. In this case, “let the seller
be forthright” is more apt.
Cloud Jumper, a struggling private company, recorded internal software use
as revenue in its unaudited financial statements. The company’s management team
knew about this practice; its Chief Executive Officer had requested it. But when the
opportunity arose to sell the company to plaintiff NetApp, Inc., Cloud Jumper kept
quiet about the so-called internal billing. After closing, NetApp discovered the
problem when Cloud Jumper’s financial results fell short of expectations. This
lawsuit for breach of contract and fraud followed.
The defendants accept that Cloud Jumper breached representations about its
financial condition in the parties’ merger agreement. They insist that these
misrepresentations were inadvertent. They also aver that NetApp was not damaged
by Cloud Jumper’s silence.
After trial, judgment is entered in favor of NetApp. Cloud Jumper breached
multiple representations in the merger agreement, including that its financial
statements were GAAP-compliant and reflected bona fide transactions. These
misstatements and others amount to fraud. NetApp also proved that it was damaged
by Cloud Jumper.
That leaves the quantification of NetApp’s damages—by far the murkiest
issue before me. The parties agree in theory that expectation damages are the proper
1
approach, but they lack a shared understanding of what that means in application.
There is even less accord when it comes to their competing measures for valuing
NetApp’s expectations. After wading through this morass, I discover some firm
footing and calculate NetApp’s damages to be just under $4.6 million.
I. FACTUAL BACKGROUND
The following facts were stipulated to by the parties or proven by a
preponderance of the evidence at trial.1 Trial was held over three days, during which
four fact witnesses and three expert witnesses testified live. The trial record includes
508 exhibits and 16 deposition transcripts.
A. Cloud Jumper’s Business Lines
Cloud Jumper LLC f/k/a Cloud Jumper Corporation is a Delaware limited
liability company that provided a platform for delivering virtual desktop
infrastructure (VDI), storage, and data management across cloud-based programs.2
Defendant Albert E. Cinelli was Cloud Jumper’s Chairman and Chief Executive
Officer and owned about 90% of the company.3 Cinelli is a lawyer by training and
1
Joint Pre-trial Stipulation and Proposed Order (Dkt. 69) (“PTO”). Facts drawn from the
exhibits jointly submitted by the parties are referred to by the numbers provided on the
parties’ joint exhibit list (cited as “JX __” unless otherwise defined). Deposition transcripts
are cited as “[Name] Dep.” Trial testimony is cited as “[Name] Tr.” See Dkts. 91-93.
2
PTO ¶ 2.
3
Id. ¶ 3; JX 267 at Tab 4. For clarity, this decision refers to Albert Cinelli as “Cinelli.”
John Cinelli and Janet Cinelli are referred to by their full names.
2
worked as an in-house corporate attorney before becoming an entrepreneur. He has
participated in about 50 mergers and acquisitions during his career.4
Cinelli acquired Cloud Jumper in 2004. At the time, he also controlled Q
Services, which provided back-office support to Cloud Jumper, and MetroNet—a
fiber optic services company.5 In 2010, Cinelli sold Cloud Jumper’s parent company
for consideration worth $818 million, spinning off Cloud Jumper, Q Services, and
MetroNet in the process.6 He remains the Chairman of MetroNet, which he and his
son John Cinelli (MetroNet’s CEO) have built into a multi-billion-dollar enterprise.7
Before February 2018, Cloud Jumper was a Managed Service Provider (MSP)
that delivered a bundled suite of third-party software to customers and provided
ongoing support and administration.8 Cloud Jumper did not have a VDI product of
its own;9 its MSP “Legacy Business” depended on VDI software licenses from a
separate company called IndependenceIT.10 In exchange for a VDI software license,
4
Cinelli Tr. 419, 464.
5
JX 310 (“Larson Dep.”) 89; JX 339 (“John Cinelli Dep.”) 75, 124, 128; PTO ¶ 13.
6
JX 13 at 5; John Cinelli Dep. 123, 142.
7
John Cinelli Dep. 26; see JX 430.
8
PTO ¶ 23.
9
VDI technology enables desktops to be centrally hosted and managed, removing the need
to maintain individual systems in data centers or server rooms. See id. ¶¶ 43-44; see also
Revised Expert Report of Gary Kleinrichert (Dkt. 85; JX 341) (“Kleinrichert Revised
Opening Rep.”) 20-22.
10
See Expert Report of George S. Hickey (Dkt. 85; JX 327) (“Hickey Opening Rep.”)
¶¶ 6-7; Kleinrichert Revised Opening Rep. 10-11.
3
Cloud Jumper paid IndependenceIT a monthly fee for each Legacy Business end
user.11 Cloud Jumper was responsible for 45% of IndependenceIT’s revenues.12
In February 2018, Cloud Jumper acquired IndependenceIT. The transaction
eliminated significant Legacy Business expenses. It also allowed Cloud Jumper to
pursue a second line of business using IndependenceIT’s software (the “Software
Business”) and access the growing VDI market.13 Cinelli financed the transaction
with a $5.2 million loan from his affiliated entity, the Albert E. Cinelli and Sharon
A. Cinelli 2014 Revocable Trust (the “Trust”).14
The MSP-based Legacy Business remained Cloud Jumper’s primary source
of revenue. Cloud Jumper expected to drive future growth by focusing on the
Software Business while phasing out the Legacy Business.15
B. The Internal Billing Practice
After the IndependenceIT acquisition closed, Cinelli instructed Sherri
VanFossen to track Cloud Jumper’s financial results as if the transaction had not
happened.16 VanFossen, an accountant employed by MetroNet and Q Services,
11
PTO ¶ 27.
12
Id.
13
Id. ¶ 25; see JX 424; Picarello Tr. 27; see also Kleinrichert Revised Opening Rep. 11.
14
JX 23. A yearly 5% interest rate applied.
15
PTO ¶¶ 24, 28; see Picarello Tr. 10, 19.
16
See JX 324 (“Cinelli Dep.”) 37 (“I gave her a direction that I wanted all the
IndependenceIT sales included in IndependenceIT, period. I had let her figure out how to
4
acted as Cloud Jumper’s de facto Chief Financial Officer.17 Cinelli told VanFossen
to track software sales attributable to IndependenceIT, which included revenue from
the Legacy Business’s use of IndependenceIT’s VDI product.18 VanFossen
expressed concern with this approach.19 Cinelli overruled her.20
Consequently, in February 2018, VanFossen implemented an accounting
practice of “billing” Cloud Jumper for using its own VDI licenses. Each VDI
software license sale was recorded as a Legacy Business “expense” and as Software
Business “revenue,” as if the two lines of business were distinct companies. 21 This
so-called “Internal Billing” practice was well known among Cloud Jumper
management. Beyond VanFossen and Cinelli, Cloud Jumper President John “JD”
Helms, Head of Sales Max Pruger, and Chief Operating Officer Frank Picarello were
aware of it.22
do it. She’s an accountant. I’m not an accountant. And she went ahead and did it and
didn’t tell me how she did it.”).
17
Picarello Tr. 22. VanFossen retired in 2021. PTO ¶ 21.
18
JX 313 (“VanFossen Dep.”) 56-57; Cinelli Tr. 425-27; PTO ¶ 29; see also JX 306
(“Helms Dep.”) 49-50.
19
VanFossen Dep. 59-60 (recalling that she told Cinelli his requested process was “not the
right way” to prepare financial reports because “you would not report revenue . . . or costs
to yourself” if “[t]here was no exchange of cash”).
20
See Cinelli Dep. 37; VanFossen Dep. 59 (“He said that’s what I want to see.”).
21
VanFossen Dep. 51-53.
22
See Picarello Tr. 45-46; Cinelli Tr. 484, 488, 491; JX 319 (“Picarello Dep.”) 23-27;
Helms Dep. 29, 67-68; PTO ¶¶ 17-18.
5
Although Cinelli and VanFossen never discussed the mechanics of the
Internal Billing practice after Cinelli’s initial instruction, the two regularly reviewed
Cloud Jumper’s financials.23 Software Business revenue reports made the Internal
Billing obvious.24 “[A]ny of the key reports . . . sorted by revenue would have Cloud
Jumper as a partner listed, if not at the top, right near the top.”25
C. Cloud Jumper’s Internal Rate Hike
Cloud Jumper required periodic capital infusions from Cinelli.26 Cinelli grew
concerned about the company’s lack of revenue generation and “heavy cash burn,”27
which required his continued financial support. His goal was for Cloud Jumper to
become “cash flow positive.”28
Cloud Jumper struggled to meet Cinelli’s expectations.29 By early 2019,
Cinelli began to pressure Cloud Jumper management to increase sales.30 In March,
23
Cinelli Tr. 426-27, 449-51; VanFossen Dep. 126 (explaining that she and Cinelli would
“go over the financials” “every month”); see also John Cinelli Dep. 175-76, 191.
24
See VanFossen Dep. 84-86; Picarello Tr. 28.
Picarello Tr. 28, 31 (“It was . . . widely understood that the company was doing this.”);
25
VanFossen Dep. 215-16.
26
PTO ¶ 34.
27
JX 15.
28
Id.
29
See JX 28.
30
Id.
6
he wrote to Helms that he was considering “terminat[ing] all our sales people” to
“reduce our cash burn” or—short of that—“terminating all sales commissions.”31
On June 14, Pruger suggested to Helms that Cloud Jumper “should change
[its] internal billing and bill [itself] $10/mth for the software” to “increase [its]
software revenue.”32 At the time, Cloud Jumper was “billing” itself $3.75 per month
for each VDI software license.33 Helms responded: “Lol . . . already told finance
that.”34 Six days later, Helms instructed Cloud Jumper’s billing department to
increase the Internal Billing rate to $8.00 per license—a 113% increase.35 This was
nearly twice the rate charged to outside customers with similar use volumes.36
Because Cloud Jumper billed in arrears, its financial statements first showed
greater revenue from the Internal Billing rate change in July 2019.37 Cloud Jumper
management knew about the increase.38 Cinelli considered it a “good business
31
JX 30.
32
JX 33.
33
See PTO ¶ 31.
34
JX 32.
35
JX 35; see PTO ¶ 31; Hughes Tr. 556-57.
36
Expert Report of Ann H. Hughes (Dkt. 85; JX 328) (“Hughes Expert Rep.”) ¶¶ 22, 53 &
Tbl.2; Hughes Tr. 551-58.
37
JX 40.
38
Picarello Tr. 45-46; VanFossen Dep. 82-84 (“Q. So this increase, when it hit the financial
statements that Al reviewed, did he know that Cloud Jumper was bringing in less money
than stated on the financial statements? . . . [A.]: Yes.”); see also Helms Dep. 64.
7
decision” because it “increased [Cloud Jumper’s] revenue.”39 The increase, of
course, was only on paper.40
D. Preliminary Talks with NetApp
Cloud Jumper’s unprofitability remained an issue throughout the summer of
2019. In August, Cinelli told Helms that his “goal [wa]s to sell the business in
2020.”41 Cinelli said that Helms stood to gain “over $5 million in profit” from a
sale.42
By October 2019, Cloud Jumper was communicating with plaintiff
NetApp, Inc., a data management company, about a potential “alliance.”43 NetApp,
which drew its business predominately from the sale of data storage appliances,
believed that the VDI market was poised for high growth and desired to expand its
cloud-based business.44
In November, the NetApp team charged with overseeing strategic transactions
received approval to investigate a VDI acquisition.45 After a market assessment,
39
Cinelli Tr. 429, 483-84, 493-94.
40
See Picarello Tr. 28.
41
JX 37.
42
Id.
43
JX 39.
44
PTO ¶¶ 40-42, 44; JX 316 (“Mitzenmacher Dep.”) 21, 25.
45
Mitzenmacher Dep. 21, 63-64.
8
Cloud Jumper was identified as a target.46 Cloud Jumper was attractive to NetApp
because of possible Software Business growth and revenue generation opportunities
from combining Cloud Jumper software with NetApp storage products.47
By January 2020, NetApp and Cloud Jumper were engaged in preliminary
merger negotiations.48 On January 17, Helms traveled to NetApp headquarters for
the parties’ first formal meeting.49 The meeting included a session on potential
synergies between NetApp and Cloud Jumper.50 Helms reported to Cinelli that the
“[m]eeting and company presentation went well” with “1.5 hours” of the 5-hour
meeting “focused on Company synergies.”51 Three days later, NetApp requested
information about Cloud Jumper’s historical revenues and revenue forecasts.52
E. The Management Projections
On January 22, Cinelli told Helms that he could “no longer sustain . . .
operating losses” and that the “only alternative” was for Cloud Jumper to “cut
expenses as soon as possible in the range of $200,000 to $250,000 per month.”53
46
PTO ¶ 45; JX 322 (“Lye Dep.”) 21.
47
Lye Dep. 159, 191.
48
Mitzenmacher Tr. 96-99.
49
Id. at 98-105.
50
JX 75 at 7.
51
JX 57.
52
JX 69; Mitzenmacher Tr. 105-06.
53
JX 72.
9
Cinelli wanted Helms’s “entire focus to be on getting sales and selling the
company.”54 This “threat” was intended to motivate Helms.55
As for the potential merger, Cinelli was “interested in negotiating directly”
with NetApp “to squeeze a little more out of them.”56 Cinelli told Helms that at an
$80 million sale price, Helms’s “gain would be in excess of $1.5 [m]illion.”57 Helms
promised Cinelli that he would “get [Cinelli] out of this burden . . . with a significant
profit.”58
An hour after this exchange with Cinelli, Helms sent Cloud Jumper’s
historical financial statements to NetApp.59 The Software Business revenue
recorded in the financial statements was overstated by more than 40% due to Internal
Billing.60 Cloud Jumper also submitted interim financials to NetApp with similarly
inflated Software Business revenue.61
54
Id.; see also Picarello Tr. 24-25.
55
Cinelli Tr. 499-500; see also Picarello Tr. 24-25.
56
JX 72.
57
Id.; see also Helms Dep. 81-82 (recalling that he was promised a bonus of $1.5 million
or 10% of the sale price).
58
JX 71.
59
JX 69.
60
Hickey Opening Rep. ¶ 28 & Tbl.2.
61
See JX 439; JX 408; JX 284.
10
On January 27, Helms sent NetApp three-year projections Cloud Jumper
management had prepared to predict future revenues and revenue growth rates (the
“Management Projections”).62 Helms’s cover email told NetApp that the forecasting
was “not that sophisticated” and doubled software revenue each year.63 Because
Cloud Jumper projected that Software Business revenue would double year-over-
year from a baseline that included Internal Billing, the revenue overstatement was
compounded.64
Cloud Jumper did not indicate that its financial statements and Management
Projections included Internal Billing.65
On February 4, Cinelli asked his team for copies of information provided to
NetApp during negotiations.66 Cinelli was told by corporate counsel, Brian Nelson,
that Cloud Jumper had shared historical financial statements and the Management
Projections with NetApp.67 Helms then forwarded Cinelli the documents NetApp
had received.68
62
See JX 408; JX 284; JX 55; JX 78; PTO ¶ 64.
63
JX 78; see also Picarello Tr. 33-36.
64
See Picarello Tr. 111; see Hickey Tr. 696.
65
Mitzenmacher Tr. 107-13.
66
JX 97.
67
JX 114. Nelson was an employee of MetroNet and Q Services. PTO ¶ 19.
68
JX 114; see also Helms Dep. 186.
11
F. NetApp’s Valuation Model
NetApp’s in-house deal team was tasked with valuing Cloud Jumper before
its Investment Committee would approve a letter of intent (LOI).69 NetApp relied
on the financial submissions from Helms to build a pre-LOI valuation model.70 Its
deal team created a revised set of standalone projections for Cloud Jumper (the
“Standalone Projections”) based on the Management Projections.71 It also
developed projections for Cloud Jumper as a unit of NetApp (the “Combined
Projections”) that reflected synergy opportunities.72 NetApp projected that Cloud
Jumper’s Software Business revenue would grow to $38.4 million by 2024.73 It
estimated a total enterprise value of $86.2 million for Cloud Jumper as a unit of
NetApp.74
NetApp’s cross-functional teams approved the Standalone and Combined
Projections.75 NetApp then prepared discounted cash flow (DCF) analyses based on
the projections, a precedent transactions analysis, and a trading comparables analysis
69
See PTO ¶¶ 50-51.
70
See Mitzenmacher Tr. 121-22, 201; JX 408; JX 284; see also JX 93.
71
See Mitzenmacher Tr. 121; Hickey Opening Rep. ¶ 12.
72
Mitzenmacher Tr. 126-31, 137-38; Hickey Tr. 681-82.
73
See JX 354 at 3; Hickey Opening Rep. at Tbl.6.
74
See JX 129 at 41; see also Hickey Opening Rep. ¶¶ 48, 53 & Ex. 1. This was the midpoint
estimate.
75
Mitzenmacher Tr. 124, 127-32; see JX 233 at 25.
12
to “triangulate” a purchase price.76 NetApp felt that the “quality of revenue” would
be the “primary argument on valuation.”77
A slide deck prepared for NetApp’s Investment Committee stated that “[last
twelve month] Revenue at ~$13.5M and ~20% [year over year] growth comfortably
support[ed] a price range below $45M.”78 An initial purchase price of “$38.5 million
including retention” was proposed.79 The Investment Committee approved
proceeding with an acquisition of Cloud Jumper for up to $40 million.80
G. The Letter of Intent and Due Diligence
On February 14, 2020, NetApp sent Cinelli a non-binding LOI to acquire
Cloud Jumper for $36 million.81 On February 24, NetApp reduced the proposed
purchase price to $35 million to fund the retention of Cloud Jumper employees who
would not receive merger consideration.82
The parties executed the LOI on February 25.83 Cinelli signed for Cloud
Jumper and former Vice President, Corporate Development Steven Mitzenmacher
76
JX 318 (“Avadhanam Dep.”) 133, 275; Mitzenmacher Tr. 251-52, 257; see JX 129.
77
JX 81 at 1.
78
JX 129 at 8.
79
Id.
80
PTO ¶¶ 69, 73.
81
JX 130; JX 131.
82
See JX 139 at 2-3; see also JX 138.
83
PTO ¶ 77; JX 142.
13
signed for NetApp.84 The LOI stated that “customary representations, warranties
and covenants” would be prepared in a definitive agreement.85
Due diligence followed amid the COVID-19 pandemic in March and April
2020.86 Cinelli planned for the worst. In March, he told Picarello to be “ready for
big cuts” if “the deal f[ell] through.”87 Picarello relayed this statement to Helms.88
Cinelli also shared with Cloud Jumper management his frustration over large
monthly expenses and declining sales, identifying layoffs as the solution.89
On March 19, Helms wrote to Picarello: “If the deal doesn’t happen the
company probably dies and does so quickly. We have to do whatever it takes to get
over the final hurdles.”90 At the same time, Helms informed NetApp that Cinelli
might “change his mind” about the deal because Cloud Jumper would “see revenue
from three major opportunities in 60 days.”91 There is no evidence in the record
about such opportunities.
84
JX 142 at 4.
85
Id. at Ex. A § F.
86
PTO ¶ 78; see Cinelli Dep. 86.
87
See JX 407.
88
Id.
89
See JX 201 (“[B]ecause of the lack of sales, I believe we still [have] too much staff that
is non-productive.”); JX 427 (“The heavy cash burn must end.”); Picarello Tr. 38-39; see
also JX 413; JX 96.
90
JX 168.
91
JX 173 at 1 (relaying information from Cloud Jumper); see Mitzenmacher Tr. 372-73.
14
H. Top Customers and Top Partners
Cloud Jumper prepared early drafts of disclosure schedules for an eventual
merger agreement, including a list of “Top Partners” and “Top Customers.” Top
Customers was defined to mean Cloud Jumper’s “top twenty (20) customers
(measured by revenue derived from such customers during the applicable period) for
the 12-month period ended February 29, 2020.”92 Top Partners meant Cloud
Jumper’s “top twenty (20) partners (measured by revenue derived from such partners
during the applicable period) for the 12-month period ended February 29, 2020.”93
On April 2, 2020, Nelson asked Picarello to obtain the raw data needed to
populate the schedules.94 Picarello retrieved the information from Cloud Jumper’s
billing system and sent it to Nelson and Helms in a spreadsheet.95 The spreadsheet
identified Cloud Jumper as its own largest “Software Partner” measured by
revenue.96
92
JX 206.
93
Id.
94
Id.
95
JX 217; JX 218; Picarello Tr. 53-56.
96
JX 218 (“Software Partners” tab); see also JX 228; JX 431.
15
Nelson excluded Cloud Jumper from the Top Customers and Top Partners
lists because it was neither a customer nor a partner.97 Cinelli reviewed the
disclosure schedules with Nelson before they were shared with NetApp.98 On April
16, Nelson sent NetApp the final disclosure schedules.99
I. The Merger Agreement
On April 17, Cinelli executed an Agreement and Plan of Merger (the “Merger
Agreement”) for NetApp to acquire Cloud Jumper.100 The Merger Agreement
included a series of representations by Cloud Jumper, including that:
• its financial statements were “prepared in accordance with GAAP”
(the “GAAP Compliance Representation”);101
• its financial statements “fairly present[ed] in all material respects,
the financial condition of the Company on a consolidated basis at
the dates therein indicated and the results of operations and cash
flows of the Company on a consolidated basis” (the “Fairly Presents
Representation”);102
• the transactions in its “books of account and other financial
records . . . represent[ed] bona fide transactions, and the revenues,
expenses, assets and liabilities of the Company [were] properly
97
See JX 305 (“Nelson Dep.”) 178-82 (describing discussions with Picarello about “the
difference between a customer and a partner” and recalling that Picarello determined that
“Cloud Jumper was not considered a partner”); JX 431; see also Picarello Tr. 59-60.
98
Cinelli Dep. 147.
99
JX 243; JX 235; see Cinelli Tr. 489.
100
JX 240 (“Merger Agreement”); PTO ¶ 80.
101
Merger Agreement § 2.7(b)(iii).
102
Id. § 2.7(b)(iv).
16
recorded therein in all material respects” (the “Bona Fide
Transactions Representation”);103
• the disclosure schedules “set[] forth a list of the Company’s Top
Customers [and] Top Partners” (the “Top Relationships
Representation”);104
• “[n]one of the representations or warranties made by the
Company . . . , and none of the statements made in any exhibit,
schedule or certificate furnished by the Company . . . contain[ed], or
w[ould] contain at the Closing, any untrue statement of a material
fact, or omit[ted] or w[ould] omit at the Closing to state any material
fact necessary in order to make the statements contained . . . therein,
in light of the circumstances under which made, not misleading”
(the “Full Disclosure Representation”);105 and
• the “estimates, projections or forecasts provided to [NetApp] were
prepared in good faith based on assumptions that the Company
believed reasonable as of the date of such projections or forecasts”
(the “Reasonable Assumptions Representation”).106
J. The Closing
Before closing, Cloud Jumper was required to submit an officer’s
certificate.107 The bring-down statements in the officer’s certificate confirmed the
accuracy of Cloud Jumper’s representations. Cinelli was the signatory and attested
103
Id. § 2.7(c).
104
Id. § 2.26.
105
Id. § 2.29.
106
Id. § 2.30.
107
Id. § 7.2(k); see Larson Tr. 397.
17
that the representations in the Merger Agreement were “true and correct, in all
material respects.”108
Meanwhile, Cinelli and Helms’s relationship had ruptured. Helms believed
that Cinelli had promised him “at least 1.5 million dollars” for “staying to drive the
business and get[ting] [Cinelli] a buyer.”109 He worried that Cinelli did not “want to
write the check and resent[ed] him.”110 On April 22, Helms reminded Cinelli that
he was “promised” a “minimum of $1.5 million at exit.”111 He told Cinelli that “no
one else could have delivered” the deal and said: “take care of me and my family as
I took care of you and yours.”112
The merger closed on April 28 for a purchase price of $35 million, $5.25
million of which was deposited into an indemnity escrow account.113 After closing,
Cinelli told Helms that there were “no funds” available for a bonus.114 They
eventually agreed that Helms would receive $300,000, payable in three
108
JX 264.
109
JX 230.
110
Id.
111
JX 256.
112
Id.
113
PTO ¶ 115.
114
JX 269.
18
installments.115 The first installment of $75,000 was paid to Helms soon after
closing;116 the other installments remain unpaid.117
K. NetApp’s Discovery of the Internal Billing
Helms and Picarello became NetApp employees. On June 7, 2020, Helms
received an email from NetApp Executive Vice President Anthony Lye that
questioned Cloud Jumper’s poor performance in the month after closing, with a
revenue disparity of $2 million on an annualized basis.118 Helms forwarded the
email to Picarello within minutes of receipt, asking: “Could this be the internal
charge for software that [Cinelli] charged[?]”119
Less than an hour later, Picarello responded to Helms that the “[g]ood [n]ews”
was he felt “confident [they] did not misrepresent the revenue as part of the [due
diligence] process.”120 Picarello wrote: “I reviewed the submissions with
[VanFossen] and the internal charge was removed.”121 The “[b]ad [n]ews,”
115
JX 271; see Cinelli Tr. 463; Cinelli Dep. 79-80, 96.
116
Helms Dep. 148.
117
Id. at 148-49.
118
JX 275 (“JD where is [sic] the difference of approximately $2M gone?”); PTO ¶ 117.
119
JX 275.
120
JX 277.
121
Id.
19
however, was that “data used to develop the pro-forma included the cross charge and
. . . the foundation for the baseline.”122
Helms did not relay this information to NetApp. Instead, he responded to Lye
that he could “only think of one thing” causing the discrepancy: the migration of a
large customer to a new contract.123
Separately, Picarello emailed VanFossen: “I am assuming that the revenue
submissions sent to NetApp during the [due diligence] phase did not include the
internal categorized ‘CloudJumper’ revenue that was a charge for software . . . Can
you confirm?”124 On June 8, she responded: “It was included.”125 VanFossen said
that she had not been “asked about” the internal charge during NetApp’s diligence
of Cloud Jumper and did not “know if [Helms] was asked about [it] or not.”126
NetApp fired Helms shortly after discovering the Internal Billing.127
A month later, NetApp decided to sunset Cloud Jumper’s VDI software,
despite the product functioning as expected.128 Cloud Jumper’s former employees
122
Id.; see also JX 278; JX 280.
123
JX 276; see Picarello Tr. 66-67.
124
JX 278.
125
Id.
126
Id.; JX 280.
127
Mitzenmacher Tr. 190, 361.
128
Lye Dep. 228-29.
20
were transferred into Spot, Inc.—another business NetApp had recently acquired—
to work on launching a different VDI platform.129
L. Procedural History
On November 20, 2020, NetApp filed a Verified Complaint in this court
against defendants Cinelli, AL.E.C Holding Corp., AEC Capital Corporation, the
Trust, John Cinelli, Janet Cinelli, David Gibson, Grant Terrell and Kelsey
MacLennan.130 AL.E.C Holding was a party to the Merger Agreement.131 AEC
Capital and the Trust were signatories to Lender Payoff and Joinder Agreements, in
which they agreed to be bound by the provisions of the Merger Agreement.132
Cinelli, John Cinelli, Janet Cinelli, Gibson, Terrell, and MacLennan had entered into
Consent, Joinder, and Support Agreements “agree[ing] to be bound by the provisions
of the Merger Agreement applicable to Company Stockholders.”133
NetApp alleged that Cloud Jumper committed fraud by including Internal
Billing in the financial statements and projections it sent NetApp, making false
representations in the Merger Agreement, and manipulating Cloud Jumper’s
129
Id. at 229.
130
Dkt. 1.
131
Merger Agreement at 72 (signature page).
132
JX 268 at 10, 21 (signature pages).
133
JX 248 at 13, 30, 47, 64, 81, 98 (signature pages).
21
financial data.134 NetApp also alleged that Cloud Jumper breached several
representations in the Merger Agreement.135
On January 21, 2021, the defendants answered the Complaint.136 Discovery
ensued over the next eighteen months.
Trial was held from July 26 to July 28, 2022. Post-trial briefing and argument
followed.137 After the parties submitted native expert exhibits to the court on
April 21, 2023, the matter was deemed submitted for decision.
II. LEGAL ANALYSIS
The defendants concede that Cloud Jumper breached certain representations
in the Merger Agreement. The parties disagree on whether other representations
were breached and whether Cloud Jumper committed fraud, which would obviate
the Merger Agreement’s $5.25 million indemnity cap on recoverable losses.138 They
further dispute NetApp’s damages.
134
Compl. ¶ 108.
135
Id. ¶¶ 125-34. The Complaint also contained a claim for failing to disclose the loss of
a top partner, which was withdrawn before trial. See PTO ¶ 119.
136
Dkt. 11.
137
Dkts. 94, 96, 99, 101-02.
138
See PTO ¶¶ 100-03.
22
After trial, I reach three essential conclusions. Cloud Jumper breached
multiple representations in the Merger Agreement. Cloud Jumper committed fraud.
And NetApp is entitled to damages of $4,598,978.
A. Breach of Contract
“Under Delaware law, the elements of a breach of contract claim are: 1) a
contractual obligation; 2) a breach of that obligation by the defendant; and 3)
resulting damage to the plaintiff.”139 The first element is met because the Merger
Agreement is a valid and enforceable contract. The defendants concede that Cloud
Jumper breached the GAAP Compliance Representation and the Fairly Presents
Representation.140 But they maintain that Cloud Jumper did not breach the Bona
Fide Transactions Representation, the Top Relationships Representation, the Full
Disclosure Representation, or the Reasonable Assumptions Representation.141
Each of these provisions involves the same general issue. Cloud Jumper
represented that it was forthright with NetApp about Cloud Jumper’s financial
condition and prospects. It was not; Cloud Jumper’s financial statements and related
139
H-M Wexford LLC v. Encorp, Inc., 832 A.2d 129, 140 (Del. Ch. 2003).
140
PTO ¶¶ 84-85; Cinelli Tr. 466-67; see also Larson Tr. 401-02; Hughes Tr. 534-43, 561-
70; Kleinrichert Tr. 851-52; see supra notes 101-02 and accompanying text; Merger
Agreement § 2.7(b)(iii)-(iv).
141
See supra notes 103-06 and accompanying text; Merger Agreement Art. II. The
defendants also aver that NetApp failed to prove damages for breaches of the GAAP
Compliance and Fairly Presents Representations. See infra Section II.B.5.
23
representations were misleading as they pertained to Cloud Jumper’s Software
Business. NetApp proved that each of the disputed provisions were breached, except
for the Top Relationships Representation.
1. Bona Fide Transactions Representation
Cloud Jumper represented in Section 2.7(c) of the Merger Agreement that “the
transactions entered [into its books of account and other financial records]
represent[ed] bona fide transactions.”142 This representation assures the quality of
the seller’s recordkeeping and is “especially important where separate audited
financial statements have not been prepared.”143
The defendants aver that NetApp failed to prove that the Bona Fide
Transactions Representation was inaccurate.144 Yet Cinelli testified that it was
false.145 The evidence supports Cinelli’s testimony.
“When the contract is clear and unambiguous,” Delaware courts will “give
effect to the plain meaning of the contract’s terms and provisions.”146 “Bona fide”
142
Merger Agreement § 2.7(c).
143
Am. Bar Ass’n, Model Stock Purchase Agreement 100 (2d ed. 2010); see also
Mitzenmacher Tr. 155-57 (testifying that Cloud Jumper’s representations “gave [NetApp]
comfort” where it lacked audited financial statements).
144
See Defs.’ Answering Post-trial Br. (Dkt. 96) (“Defs.’ Post-trial Br.”) 29 n.13.
145
Cinelli Tr. 468; Cinelli Dep. 130.
146
Osborn ex rel. Osborn v. Kemp, 991 A.2d 1153, 1159-60 (Del. 2010) (citing Rhone-
Poulenc Basic Chem. Co. v. Am. Motorists Ins. Co., 616 A.2d 1192, 1195 (Del. 1992)).
24
is not defined in the Merger Agreement.147 According to Black’s Law Dictionary,
the term means “sincere; genuine.”148 “Genuine,” in turn, is defined as “authentic
or real; having the quality of what a given thing purports to be or to have.”149 The
Internal Billings reflected in Cloud Jumper’s financial statements were not genuine.
NetApp’s expert Ann H. Hughes, a Managing Director of Coherent
Economics, explained that bona fide transactions on financial statements reflect
“revenues from a third party.”150 The Internal Billings lacked economic substance.
There was no inflow of cash from a third party to Cloud Jumper.151
The defendants’ only rebuttal is that Cloud Jumper charged itself a “market”
rate for internal software usage, which was somehow “passed on to the end
customers.”152 That is beside the point. The Internal Billing transactions listed on
147
Cf. Merger Agreement at App. I.
148
Bona fide, Black’s Law Dictionary (11th ed. 2019); see Lorillard Tobacco Co. v. Am.
Legacy Found., 903 A.2d 728, 738 (Del. 2006) (explaining that Delaware courts “look to
dictionaries for assistance in determining the plain meaning” of contractual terms).
149
Genuine, Black’s Law Dictionary (11th ed. 2019).
150
Hughes Tr. 546-60. Hughes is a Managing Director at Coherent Economics. She has a
bachelor’s degree in accounting, an M.B.A. from the University of Chicago Booth School
of Business, and is a Certified Public Accountant and Chartered Financial Analyst. Hughes
has worked in various financial, accounting, and expert roles. Hughes Expert Rep. ¶¶ 1-9.
151
See Hughes Tr. 560 (explaining that the Internal Billings “fail to satisfy GAAP criteria
for revenue recognition”); Hughes Expert Rep. ¶¶ 48-55; see also VanFossen Dep. 60
(“There was no exchange of cash.”).
152
Defs.’ Post-trial Br. 29 n.13.
25
the financial statements Cloud Jumper gave NetApp were not genuine. The Bona
Fide Transactions Representation was thus breached.
2. Full Disclosure and Reasonable Assumptions Representations
In Section 2.29, Cloud Jumper promised that the representations in the Merger
Agreement and “statements made in any . . . schedule or certificate furnished by the
Company” were not materially false or misleading.153 The GAAP Compliance,
Fairly Presents, and Bona Fide Transactions Representations contained untrue
statements of material fact. It follows that the Full Disclosure Representation was
also breached.154
Cloud Jumper represented in Section 2.30(A) of the Merger Agreement that
“any estimates, projections or forecasts provided to [NetApp] were prepared in good
faith based on assumptions that the Company believed reasonable as of the date of
such projections or forecasts.”155 The Management Projections were based on
historical financial statements that included Internal Billings and compounded the
153
Merger Agreement § 2.29.
154
See Am. Bar Ass’n, Model Merger Agreement, 104 (2011) (observing that similar
representations should be subject to “a strict liability standard” based on “materiality,
regardless of the target’s good faith attempts to make the disclosure schedules as complete
and accurate as possible”); cf. Rubén Kraiem, Leaving Money on the Table: Contract
Practice in a Low-Trust Environment, 42 Colum. J. Transnat’l. L. 715, 724 (2004)
(describing “full-disclosure representation” provisions as “a catch-all that incorporates a
securities anti-fraud standard”).
155
Merger Agreement § 2.30; see Mitzenmacher Tr. 184.
26
Internal Billings’ effect on Software Business projected revenues.156 For example,
more than 40% of the Software Business revenues forecast for 2023 were
attributable to Internal Billing.157
The defendants did not address this provision in their post-trial brief, waiving
any related argument.158 In any event, as described below, Cloud Jumper’s inclusion
of Internal Billings in its Management Projections cannot be excused as a good faith
mistake.159 The Reasonable Assumptions Representation was breached.
3. Top Relationships Representation
Cloud Jumper’s Top Customers and Top Partners were described in
Section 2.26 of the Merger Agreement disclosure schedules.160 The Top Customers
and Top Partners listed in the schedules were “measured by revenue derived from”
them.161 NetApp asserts that the Top Relationships Representation was breached
156
See Hickey Tr. 712-14.
157
Id. at 696; compare Hickey Opening Rep. at Tbl.2 (identifying Internal Billing revenue
as 42% of Software Business revenues in 2018 and 43% in 2019) with id. at Tbl.3
(projecting software revenue growth that included Internal Billings) and id. at Tbl.4
(comparing revenue projections with Internal Billings included and Internal Billings
removed).
158
See Oxbow Carbon & Minerals Hldgs., Inc. v. Crestview-Oxbow Acq., LLC, 202 A.3d
482, 502 n.77 (Del. 2019) (“The practice in the Court of Chancery is to find that an issue
not raised in post-trial briefing has been waived, even if it was properly raised pre-trial.”).
159
See infra Section II.B.2.
160
Merger Agreement § 2.26.
161
Id. at App. I (definitions of “Top Customers” and “Top Partners”).
27
because Cloud Jumper did not list itself as a Top Customer or Top Partner—despite
Cloud Jumper’s internal data suggesting otherwise.162
NetApp’s position is undercut by the fact that the Internal Billings were
neither GAAP compliant nor bona fide transactions. If the Internal Billings did not
represent an influx of revenue from a third party, then Cloud Jumper was not its own
Top Customer or Top Partner as those terms are defined in the Merger Agreement.163
Although the Top Relationships Representation forms part of a pattern of fraudulent
conduct by Cloud Jumper, excluding Cloud Jumper from the list of Top Customers
and Top Partners did not breach the Merger Agreement.164
B. Fraud
Section 8.2(a) of the Merger Agreement permits indemnification claims by
NetApp against the “Beneficial Indemnity Holders” for “Losses” incurred from
“Fraud committed by the Company or its stockholders, Affiliates, employees or
representations . . . upon which NetApp acted in reliance.”165 The Merger
162
Pl.’s Post-trial Opening Br. (Dkt. 94) 24.
Defs.’ Post-trial Br. 33-34. Hughes agreed with this view. See Hughes Tr. 641-43;
163
Hughes Dep. 148-49.
164
See infra Section II.B.
165
See Merger Agreement § 8.2(a); id. at App. I (d)-(c). “Losses” is defined as “all claims,
losses, liabilities, damages, deficiencies, taxes, costs, interest, awards, judgments, penalties
and expenses, including reasonable attorneys’ and consultants’ fees and expenses and
including any such expenses incurred in connection with investigating, defending against
or settling any of the foregoing; provided, that any punitive damages shall not be included
in the definition of Losses unless actually paid or obligated to be paid to a third party.”
28
Agreement defines “Fraud” as “fraud, willful breach or intentional
misrepresentation, as determined by a final and non-appealable judgment, upon
which [NetApp] acted in justifiable reliance and which resulted in actual
damages.”166
The elements of common law fraud are:
(1) a false representation, usually one of fact, made by the
defendant; (2) the defendant’s knowledge or belief that the
representation was false, or was made with reckless indifference
to the truth; (3) an intent to induce the plaintiff to act or to refrain
from acting; (4) the plaintiff’s action or inaction taken in
justifiable reliance upon the representation; and (5) damage to
the plaintiff as a result of such reliance.167
Each element of fraud must be proven by a preponderance of the evidence.168
Id. § 1.1(f). The Beneficial Indemnity Holders and their respective “Indemnity Allocation
Percentages” are: Cinelli (31.47%); John Cinelli (2.34%); Janet Cinelli (0.13%); David
Gibson (0.07%); Grant Terrell (0.07%); Kelsey MacLennan (0.01%); AEC Capital
Corporation (39.39%); and the Trust (26.53%). Id. at App. I (ll); JX 267 at Tab 4; PTO
¶¶ 96-97.
166
Merger Agreement at App. I(ee) (defining “Fraud”).
167
Stephenson v. Capano Dev., Inc., 462 A.2d 1069, 1074 (Del. 1983); see also Great Hill
Equity P’rs IV, LP v. SIG Growth Equity Fund I, LLLP, 2018 WL 6311829, at *32 (Del.
Ch. Dec. 3, 2018) (citing E.I. DuPont de Nemours & Co. v. Fla. Evergreen Foliage, 744
A.2d 457, 461-62 (Del. 1999)).
168
See Arwood v. AW Site Servs., LLC, 2022 WL 705841, at *21 (Del. Ch. Mar. 9, 2022);
Stone & Paper Invs., LLC v. Blanch, 2021 WL 3240373, at *26 (Del. Ch. July 30, 2021)
(“Under Delaware law, a plaintiff must prove fraud by a preponderance of the evidence.”
(citing In re IBP, Inc. S’holders Litig., 789 A.2d 14, 54 (Del. Ch. 2001))). The Court of
Chancery has questioned whether a higher standard of proof is required for fraud claims.
See, e.g., Project Boat Hldgs., LLC v. Bass Pro Grp., LLC, 2019 WL 2295684, at *23 (Del.
Ch. May 29, 2019) (“There is some uncertainty in our law as to whether a plaintiff asserting
fraud must prove the claim by clear and convincing evidence or whether a preponderance
of the evidence will suffice.”). The weight of authority in Delaware applies a
29
1. False Representations
Under Delaware law, “fraud can occur in one of three ways: (1) an overt
misrepresentation; (2) silence in the face of a duty to speak; or (3) active
concealment of material facts.”169
There were several overt misrepresentations in the Merger Agreement.170
The individuals responsible for these misrepresentations were Cloud Jumper officers
and directors.171 Their knowledge and acts are imputed to Cloud Jumper.172
Cloud Jumper’s Top Relationships Representation was not explicitly false.173
Nor did Cloud Jumper actively conceal that it was, in some respects, its own top
preponderance standard to fraud claims. E.g., Roma Landmark Theaters, LLC v. Cohen
Exhibition Co. LLC, 2021 WL 2182828, at *8 n.12 (Del. Ch. May 28, 2021); Trascent
Mgmt. Consulting, LLC v. Bouri, 2018 WL 4293359, at *17 (Del. Ch. Sept. 10, 2018).
Neither party advocates otherwise.
169
In re Am. Int’l Grp., Inc., Consol. Deriv. Litig., 965 A.2d 763, 804 (Del. Ch. 2009), aff’d
sub nom. Tchrs.’ Ret. Sys. of La. v. PricewaterhouseCoopers LLP, 11 A.3d 228 (Del. 2011)
(TABLE).
170
See supra Section II.A (analyzing breaches of these representations).
171
See JX 243 at 2.
172
See, e.g., Teachers’ Ret. Sys. of La. v. Aidinoff, 900 A.2d 654, 671 n. 23 (Del. Ch. 2006)
(“[I]t is the general rule that knowledge of an officer or director of a corporation will be
imputed to the corporation.”); Metro Commc’n Corp. BVI v. Advanced Mobilecomm Techs.
Inc., 854 A.2d 121, 153-55 (Del. Ch. 2004) (imputing fraud to the corporation where the
manager of a limited liability corporation designated by the corporation made false
statements); Nolan v. E. Co., 241 A.2d 885, 891 (Del. Ch. 1968) (“Knowledge of an agent
acquired while acting within the scope of his authority is imputable to the principal.”), aff’d
sub nom. Nolan v. Hershey, 249 A.2d 45 (Del. 1969); New Enter. Assocs. 14, L.P. v. Rich,
292 A.3d 112, 140 n.15 (Del. Ch. 2023).
173
See supra notes 163-64 and accompanying text.
30
customer and top partner.174 Cloud Jumper was, however, “silen[t] in the face of a
duty to speak”175 about this reality.
A duty to speak can arise before the consummation of a business transaction
when a party acquires information that is “necessary to prevent [a] partial or
ambiguous statement of the facts from being misleading.”176 An incomplete
statement can amount to fraud when a party “purports to tell the whole truth” but
fails to “disclose the additional information necessary to prevent the statement from
misleading the recipient.”177 If Cloud Jumper had been forthcoming with NetApp,
it would have explained that though it was not technically a Top Customer or Top
174
See Metro Commc’n, 854 A.3d at 150 (describing deliberate concealment as taking
“some action affirmative in nature or designed or intended to prevent, and which does
prevent, the discovery of facts giving rise to the fraud claim, some artifice to prevent
knowledge of the facts or some representation intended to exclude suspicion and prevent
inquiry” (quoting Lock v. Schreppler, 426 A.2d 856, 860 (Del. Super. 1981))). According
to NetApp, Nelson and Helms revised the data Picarello pulled from Cloud Jumper’s
billing system to hide the Internal Billings. See supra notes 94-99 and accompanying text;
see also Pl.’s Post-trial Opening Br. 15-17. But the record lacks evidence of manipulation.
The raw data identified Cloud Jumper as its own leading “Software Partner.” JX 218 at
“Software Partners” tab; see also JX 217; Picarello Tr. 53. A tab of the spreadsheet called
“Total >$25K” listed the companies from which Cloud Jumper received more than $25,000
in revenue during 2019. JX 217; JX 218. Cloud Jumper was not included. The spreadsheet
subsequently created by Nelson continued to list Cloud Jumper as its top “Software
Partner” but—consistent with the raw data—did not list Cloud Jumper in the “Total >$25k”
tab of Top Partners and Top Customers. JX 228 at “Software Partners” & “Total >$25K”
tabs. The Top Partners and Top Customers lists later sent to NetApp likewise excluded
Cloud Jumper. See JX 235; JX 243 at 63-64, 96.
175
Stephenson, 462 A.2d at 1074.
176
Restatement (Second) of Torts § 551(2)(b) (1977).
177
Id. § 551 cmt. g.
31
Partner as defined in the Merger Agreement, its internal records listed Cloud Jumper
as its own leading Software Business partner.178 Cloud Jumper personnel never
disclosed this information to NetApp, despite sharing financial statements that they
knew included—but did not identify—Internal Billings.179
2. Scienter
“After showing that a false representation was made, a plaintiff must show
that the defendant had knowledge of the falsity of the representation or made the
representation with reckless indifference to the truth.”180 Direct evidence of a
defendant’s state of mind is not necessary to prove scienter. Rather, a plaintiff need
only present “facts ‘establishing a motive and an opportunity to commit fraud’” or
“constitut[ing] circumstantial evidence of either reckless or conscious behavior.”181
“In cases where a fraud claim centers on a transaction, the transaction itself may
serve as both the motive and opportunity to commit the fraud.”182
178
See JX 228; supra notes 162-64 and accompanying text.
179
See Picarello Tr. 61 (testifying that the disclosure schedules to Section 2.26 should have
included Cloud Jumper to be “consistent with the data submissions”); VanFossen Dep.
119.
180
Great Hill, 2018 WL 6311829, at *32.
181
Deloitte LLP v. Flanagan, 2009 WL 5200657, at *8 (Del. Ch. Dec. 29, 2009) (quoting
Weiner v. Quaker Oats Co., 129 F.3d 310 (3d Cir. 1997)); see also Maverick Therapeutics,
Inc. v. Harpoon Therapeutics, Inc. (Maverick I), 2020 WL 1655948, at *29 (Del. Ch. Apr.
3, 2020) (“Such scienter may be demonstrated through circumstantial evidence, including
demonstrating motive and opportunity for inducement.”).
182
Maverick I, 2020 WL 1655948, at *29.
32
It is a close call on whether Cloud Jumper personnel intended to deceive
NetApp with statements they knew were false.183 But there is no doubt that Cloud
Jumper was reckless. Recklessness is more than “inexcusable negligence.”184 It is
“a conscious disregard for the truth” departing from the ordinary standard of care.185
Put differently, “[r]ecklessness requires ‘a conscious indifference to the decision’s
foreseeable results,’”186 but not “[a] deliberate state of mind.”187
The Internal Billing practice was implemented at Cinelli’s request.188 It was
“common knowledge” at Cloud Jumper.189 Upper level management knew that there
183
Helms is closest to the line. See Helms Dep. 67. He shared Cloud Jumper’s financial
statements and projections with NetApp, while believing that he would receive millions of
dollars in the event of a sale. After the sale, when confronted by Lye about the revenue
shortfall, he obfuscated. See supra notes 118-23 and accompanying text. Still, I hesitate
to find that he acted intentionally without the benefit of his live testimony.
184
In re Wayport, Inc. Litig., 76 A.3d 296, 326 (Del. Ch. 2013) (citing Metro Commc’n,
854 A.2d at 143).
185
Maverick I, 2020 WL 1655948, at *28 (describing recklessness as “a conscious
disregard for the truth”); see also In re Wayport, Inc. Litig., 76 A.3d 296, 326 (Del. Ch.
2013); Great Hill, 2018 WL 6311829 (describing recklessness as “an extreme departure
from the standards of ordinary care” (quoting Deloitte, 2009 WL 5200657, at *8)).
186
Wolf v. Magness Constr. Co., 1994 WL 728831, at *5 (Del. Ch. Dec. 20, 1994) (citation
omitted).
187
Express Scripts, Inc. v. Bracket Hldgs. Corp., 248 A.3d 824, 834 (Del. 2021); see also
Restatement (Third) of Torts: Liab. for Econ. Harm § 10(c) (2020) (noting that “‘reckless’
has a range of meanings in the law” and that “[t]he recklessness sufficient to support a
claim of fraud occurs when a speaker acts in conscious disregard of a risk that a statement
is false, as by offering it without qualification while knowing that it may well be untrue”).
188
See Cinell Tr. 425-27; Helms Dep. 49-50; VanFossen Dep. 56-57.
189
Cinelli Tr. 488-91; see id. at 482-83, 526-27; Picarello Tr. 28, 30-31; JX 33; JX 32;
JX 35; PTO ¶¶ 29-30; VanFossen Dep. 56-57.
33
was “no real revenue associated” with the Internal Billings.190 Company officers
joked about raising the Internal Billing rate days before a 113% increase was
implemented.191 Cloud Jumper officers also knew that the Internal Billings were
recorded on Cloud Jumper’s financials.192 Cinelli, for one, acknowledged that
tracking of the Internal Billings was “artificial[]” and lacked “an accounting
basis.”193
Cloud Jumper’s Internal Billing would not have been a problem in isolation.
There is nothing inherently wrong with a private company adopting
non-GAAP-compliant accounting measures for its unaudited financial statements.194
The circumstances changed when Cloud Jumper shared financial submissions with
NetApp that included—but did not call out—the Internal Billings and made a series
of related misrepresentations.195
Cloud Jumper acted recklessly when it endorsed representations that the
Internal Billings represented real revenue, that Cloud Jumper’s financials were
GAAP-compliant and reflected bona fide transactions, and that Cloud Jumper’s top
190
Picarello Tr. 28, 44-45.
191
JX 32; JX 33; JX 35.
192
Cinelli Tr. 483-84, 488-89, 493, 526-27; Helms Dep. 64, 67; Picarello Tr. 28, 61;
VanFossen Dep. 215-16.
193
Cinelli Dep. 39.
194
See Hughes Tr. 581-82; Hughes Dep. 30-31, 52-53.
195
See JX 69; JX 78; JX 111; JX 114.
34
relationships were with third parties.196 It should have been obvious to Cloud Jumper
that its financial statements were inflated and that its associated representations to
NetApp were untrue.197 The Internal Billings constituted more than 40% of the
Software Business’s revenue—the only business Cloud Jumper expected to continue
after 2022.198 Yet Cloud Jumper officers consciously overlooked “specific warning
signs” related to Internal Billing that signaled Cloud Jumper’s representations were
false.199 It is not credible that Cloud Jumper simply forgot about the Internal Billing
practice during merger negotiations.
196
See supra notes 101-06 and accompanying text.
197
See PR Diamonds, Inc. v. Chandler, 364 F.3d 671, 684 (6th Cir. 2004) (“[A]n inference
of knowledge or recklessness may be drawn from allegations of accounting violations that
are so simple, basic, and pervasive in nature, and so great in magnitude, that they should
have been obvious to a defendant.”), abrogated in part on other grounds by Frank v. Dana
Corp., 646 F.3d 954, 961 (6th Cir. 2011); see also In re Oxford Health Plans Inc. Secs.
Litig., 51 F. Supp. 2d 290, 295 (S.D.N.Y. 1999) (noting that recklessness could be inferred
from “[a]n egregious refusal to see the obvious, or to investigate the doubtful” (citation
omitted)); Kinney v. Metro Glob. Media, Inc., 170 F. Supp. 2d 173, 180 (D.R.I. 2001)
(“[T]he magnitude of reporting errors may lend weight to allegations of recklessness where
defendants were in a position to detect the errors. . . . The more serious the error, the less
believable are defendants [sic] protests that they were completely unaware of [the
company’s] true financial status and the stronger is the inference that defendants must have
known about the discrepancy.” (citation omitted)); In re MicroStrategy, Inc. Sec. Litig.,
115 F. Supp. 2d 620, 636-37 (E.D. Va. 2000) (“[W]hile alleging a misapplication of
[GAAP] standing alone is insufficient, such allegation when combined with a drastic
overstatement of financial results can give rise to a strong inference of scienter.” (citation
omitted)).
198
PTO ¶ 28; JX 55 at AA3, AA5; JX 30; Helms Dep. 62-63; see also Hickey Opening
Rep. at Tbl.2.
199
Metro Commc’n, 854 A.3d at 147; see also Miller v. Johnson, 1980 WL 333066, at *3
(Del. Super. 1980) (“The mere fact that a speaker did not intend to misrepresent may not
be his defense if he is chargeable with the means to verify the accuracy.”); Arwood, 2022
35
Further, Cloud Jumper personnel had motives to conceal the Internal Billing
during due diligence. Cloud Jumper was burning cash rapidly and its leadership was
under growing pressure from Cinelli, who hoped to “squeeze” NetApp for a higher
price.200 Some members of Cloud Jumper management faced the prospect of losing
their jobs.201 Others, such as Helms, expected that a successful merger would bring
a substantial payday and felt that Cloud Jumper needed to do “whatever it takes” to
close a deal.202 These motives provide circumstantial evidence of scienter to commit
fraud.203
WL 705841, at *22 (“It is often difficult to discern precisely what is, or was, in the mind
of an actor accused of fraud, which is why our law allows the factfinder to rely upon
circumstantial evidence when determining whether sufficient proof of scienter exists in a
fraud case.”).
200
JX 72; see Cinelli Dep. 87-88.
201
E.g., JX 30; JX 413; JX 201.
202
JX 168; see JX 138; JX 230; JX 72; Helms Dep. 81-82; JX 71.
203
See Cobalt Operating, LLC v. James Crystal Enters., LLC, 2007 WL 214926, at *25
(Del. Ch. July 20, 2007) (concluding that managers had a motive to perpetrate a fraudulent
scheme “to make a sale more likely” because they “had been promised substantial bonuses
if a sale occurred”), aff’d, 945 A.2d 594 (Del. 2008) (TABLE); id. at *3 (finding that a
defendant’s “participation in . . . fraud” was explained by the “simple fact” that she “wanted
to keep her job”); id. at *14 (observing that the “scope of the alleged fraud was at its
greatest during the time when Crystal had the strongest motive to inflate its cash flow [] to
make sure a deal got done and to squeeze a higher price out of Cobalt”); see also Arwood,
2022 WL 705841, at *22 (“[M]otive to achieve a higher price . . . may alone support . . .
an inference of scienter.”).
36
3. Intent to Induce Reliance
“A misrepresentation induces a party’s manifestation of assent if it
substantially contributes to his decision to manifest his assent.”204 Where a party
bargains for written representations in a transaction agreement and a counterparty
provides them, it is “reasonably inferable that the [counterparty] intended to induce
reliance.”205
The defendants do not contest this element. Nor could they. NetApp
bargained for the representations and warranties in the Merger Agreement. NetApp
also obtained so-called “pro-sandbagging” language in Section 8.3 of the Merger
Agreement.206 Cloud Jumper personnel made or endorsed the challenged
representations in support of closing the merger. On these facts, it is apparent that
Cloud Jumper intended for NetApp to rely on the false and misleading descriptions
of its financial health.
4. Justifiable Reliance
NetApp must prove not only that Cloud Jumper intended for it to rely on the
false statements, but also that it took (or refrained from taking) action in justifiable
204
Trascent Mgmt. Consulting, LLC v. Bouri, 2018 WL 4293359, at *17 (Del. Ch. 2018)
(citations omitted).
205
Prairie Cap. III, L.P. v. Double E Hldg. Corp., 132 A.3d 35, 62 (Del. Ch. 2015).
206
Merger Agreement § 8.3(d)(ii).
37
reliance on the statements.207 “[J]ustifiable reliance requires that the representations
relied upon involve matters which a reasonable person would consider important in
determining his course of action in the transaction in question.”208 This element is
“easily met” where “the false statements at issue are contained in a written
agreement.”209
The defendants suggest that NetApp’s reliance was unjustified because
NetApp had broad access to information during due diligence.210 NetApp submitted
“high priority” diligence requests about Cloud Jumper’s accounting policies on
revenue recognition, and about transactions with partners and customers.211 The
information NetApp received from Cloud Jumper, however, obscured the Internal
Billings in Cloud Jumper’s historical financial statements and Management
Projections.
207
See Craft v. Bariglio, 1984 WL 8207, at *8 (Del. Ch. Mar. 1, 1984). NetApp’s breach
of contract claim does not require proof of justifiable reliance. NetApp was entitled to rely
upon Cloud Jumper’s representations, which “serve an important risk allocation function.”
Cobalt, 2007 WL 2142926, at *28.
208
Craft, 1984 WL 8207, at *8.
209
LVI Grp. Invs., LLC v. NCM Grp. Hldgs., LLC, 2018 WL 1559936, at *13 n.198 (Del.
Ch. Mar. 28, 2018).
210
The defendants’ post-trial brief makes this argument concerning scienter and active
concealment, but—to my mind—it is more relevant to reliance.
211
JX 150 at 3-4, 8; see Mitzenmacher Tr. 149-60.
38
NetApp relied on Cloud Jumper’s financial submissions when considering
whether to pursue the deal, securing Investment Committee authorization to proceed
with an LOI and Merger Agreement, and determining a purchase price. For
example, it used Cloud Jumper’s historical financial statements to populate a
spreadsheet analyzing “Consolidated P&L – Quarterly” and used the Management
Projections to create a “3 Year Forecast.”212 The resulting analyses overstated
Software Business revenue because the underlying data from Cloud Jumper included
Internal Billings.213
The parties agreed that Cloud Jumper would make certain financial
representations in the Merger Agreement. They agreed to allocate risk regarding the
accuracy of these representations to Cloud Jumper.214 And they agreed that
NetApp’s diligence would not alter their bargained-for risk allocation.215 NetApp
had no reason to investigate whether Cloud Jumper’s financial submissions recorded
intracompany transactions that lacked economic substance.216 NetApp’s reliance
was justified.
212
See JX 93.
213
See id.; JX 402.
214
Merger Agreement § 8.3(d)(ii).
215
Id.
216
Mitzenmacher Tr. 110-13, 154-55; see Cobalt, 2007 WL 2142926, at *28 (“By
obtaining the representations it did, [the buyer] placed the risk that [the seller’s] financial
statements were false and that [the seller] was operating in an illegal manner on [the
39
5. Damages
Damages is an element of both NetApp’s breach of contract and fraud claims.
NetApp has the burden to prove its damages by a preponderance of the evidence.217
It must first demonstrate with “reasonable certainty” that it was damaged by the
challenged conduct.218
The fact of NetApp’s damages is not in doubt. At trial, Mitzenmacher
credibly testified that NetApp would “[a]bsolutely not” have closed the merger if it
had been aware of Cloud Jumper’s falsities.219 NetApp reasonably believed that the
Internal Billings represented true revenue since Cloud Jumper never indicated
otherwise. It was surprised to learn post-closing that the Software Business was less
profitable than described.220
seller]. . . . Its need then, as a practical business matter, to independently verify those
things was lessened.”); Tam v. Spitzer, 1995 WL 510043, at *9 (Del. Ch. Aug. 17, 1995)
(observing that a buyer is entitled to rely on contractual representations and “is under no
duty to investigate the accuracy of representations made by the seller concerning its
profitability and operational affairs, even when there is an opportunity to do so”).
217
See, e.g., In re Mobilactive Media, LLC, 2013 WL 297950, at *24 (Del. Ch. Jan. 25,
2013).
218
Siga Techs., Inc. v. PharmAthene, Inc. (SIGA II), 132 A.3d 1108, 1111 (Del. 2015); see
also Tanner v. Exxon Corp., 1981 WL 191389, at *1 (Del. Super. July 23, 1981)
(“Reasonable certainty is not equivalent to absolute certainty; rather, the requirement that
plaintiff show defendant’s breach to be the cause of his injury with ‘reasonable certainty’
merely means that the fact of damages must be taken out of the area of speculation.”
(citation omitted)).
219
Mitzenmacher Tr. 367.
220
See id. at 187-92; Lye Dep. 226-27; JX 275.
40
That leaves the amount of NetApp’s damages, which I turn to next.
C. Remedy
Under Delaware law, the standard remedy for breach of contract “is based
upon the reasonable expectations of the parties ex ante.”221 Similarly, “[t]he
recipient of a fraudulent misrepresentation is entitled to recover as damages . . . the
pecuniary loss to him of which the misrepresentation is a legal cause.”222 Such
expectation—or benefit-of-the-bargain—damages are measured by the amount of
money that would put the plaintiff in the position it would have held if the
defendant’s representations were true.223 A less common approach is the
out-of-pocket measure, which is “designed to restore the plaintiff to his financial
position before the transaction occurred.”224 A plaintiff may elect to proceed on
221
SIGA II, 132 A.3d at 1130 (quoting Duncan v. Theratx, Inc., 775 A.2d 1019, 1022 (Del.
2001)).
222
Restatement (Second) of Torts § 549(1); cf. Envo, Inc. v. Walters, 2009 WL 5173807,
at *7 n.37 (Del. Ch. Dec. 30, 2009) (“Delaware courts have cited the Restatement (Second)
of Torts [§] 549 . . . with approval.”), aff’d, 2013 WL 1283533 (Del. Mar. 28, 2013)
(TABLE).
223
SIGA II, 132 A.3d at 1130 (quoting Duncan, 775 A.2d at 1022); Stephenson, 462 A.2d
at 1076 (explaining that awarding benefit-of-the-bargain damages “put[s] the plaintiff in
the same financial position that [the plaintiff] would have been in if the defendant’s
representations had been true”); see also Restatement (Second) of Torts § 549, at
Illustrations 4-5; Restatement (Second) of Contracts § 347, cmt. a (1981) (“Contract
damages are ordinarily based on the injured party’s expectation interest and are intended
to give him the benefit of his bargain by awarding him a sum of money that will . . . put
him in as good a position as he would have been in had the contract been performed.”).
224
Stephenson, 462 A.2d at 1076.
41
either theory.225 Damages are measured from the plaintiff’s perspective at the time
of the breach.226
1. The Parties’ Legal Arguments on Damages
Despite agreeing that damages for breach of contract and fraud are typically
awarded using the benefit-of-the-bargain measure, the parties have diverging views
on how such damages are calculated. According to the defendants, a proper
benefit-of-the-bargain analysis should measure the difference between the “as-
represented” value of Cloud Jumper (the $35 million purchase price) and the
“actual” value of Cloud Jumper (if its revenues were accurately reported).227
NetApp, for its part, insists that the defendants’ approach to expectation damages is
wrong because “analyses that compare actual value to what NetApp paid measure
out-of-pocket damages.”228 From NetApp’s perspective, its expectation damages
should address the future cash flows it planned to generate from the acquisition,
irrespective of the purchase price.229
225
Id.226
See id.; Strassburger v. Earley, 752 A.2d 557, 579 (Del. Ch. 2000) (noting that
“compensatory damages are determined at the time of the transaction”).
227
Defs.’ Post-trial Br. 44 (citing Zayo Grp., LLC v. Latisys Hldgs., LLC, 2018 WL
6177174, at *16 (Del. Ch. Nov. 26, 2018)); id. at 48.
228
Pl.’s Post-trial Reply Br. 35 (citing Stephenson, 462 A.2d at 1076) (emphasis removed).
229
See id. at 25-26, 29-32.
42
To resolve the parties’ conceptual dispute, I look to precedent. The general
descriptions of benefit-of-the-bargain and out-of-pocket damages found in our law
are of limited utility. Stephenson v. Capano Development, Inc. counsels that benefit-
of-the-bargain damages “are equal to ‘the difference between the actual and the
represented values of the object of the transaction.’”230 Out-of-pocket damages, by
contrast, are “equal to ‘the difference between what [the plaintiff] paid and the actual
value of the item’ that the plaintiff received.”231 This seems clear—unless the
purchase price is the represented value used to calculate expectation damages, in
which case the two measures collapse into one another.232
Precedent in the M&A context provides more illuminating guidance. In that
setting, Delaware courts routinely use the purchase price as the starting point for
benefit-of-the-bargain damages calculations. This makes sense. The purchase price
for a company is often the result of arms’-length negotiations between sophisticated
230
LCT Cap., LLC v. NGL Energy P’rs LP, 249 A.3d 77, 91 (Del. 2021) (quoting
Stephenson, 462 A.2d at 1076).
231
Id.232
A basic hypothetical highlights the problem. Assume a plaintiff buyer purchased an
item from the defendant seller that had a represented value of $1,000,000, though the item
was actually worth $700,000. The buyer paid $900,000 for the item. The plaintiff’s out-
of-pocket damages would be $200,000—the difference between what she paid ($900,000)
and received ($700,000). Her benefit-of-the-bargain damages, by contrast, would be
$300,000—the difference between the misrepresented value ($1,000,000) and the actual
value received ($700,000). If the represented value were the $900,000 purchase price,
damages would be the same under either approach.
43
parties and reflects the potential risks and rewards of execution.233 The price might
have been established with a market approach using a multiple, or an income
approach using a discount rate.234 Damages, then, may be calculated using the
corresponding method to account for any diminution in value attributable to the
misrepresentation.235
In Tam v. Spitzer, for example, the defendant seller knew that its largest
customer would soon be terminating its business relationship with the seller but
withheld this information from the buyer.236 Then-Vice Chancellor Jacobs found
that the transaction was induced by false misrepresentations amounting to common
233
See Maverick Therapeutics, Inc. v. Harpoon Therapeutics, Inc. (Maverick II), 2021 WL
1592473, at *12 (Del. Ch. Apr. 23, 2021) (“The [purchase] price . . . necessarily factors in
the low probability of ultimate success as well as the potentially large pay-off upon such
success.”); see also Sharma v. Skaarup Ship Mgmt. Corp., 916 F.2d 820, 825 (2d Cir. 1990)
(“[T]he value of the item at the time of the breach . . . actually takes expected lost future
profits into account.”).
234
See, e.g., Tam, 1995 WL 510043, at *10, *12 (calculating expectation damages based
on values at the time of the transaction, which incorporated future expectations); Cobalt,
2007 WL 2142926, at *30 (awarding damages using a valuation based on expectations of
future cash flow).
235
See WaveDivision Hldgs., LLC v. Millennium Dig. Media Sys., L.L.C., 2010 WL
3706624, at *22-23 (Del. Ch. Sept. 17, 2010) (rejecting a DCF method and calculating
expectation damages using a multiple of EBITDA analysis where it was the approach on
which the buyer based its expectations); cf. Zayo, 2018 WL 6177174, at *17 (criticizing
the use of “an EBITDA multiple as the most accurate and comprehensive metric for valuing
damages” where there was “no evidence” that the purchase price was based on a multiple
of EBITDA).
236
1995 WL 510043, at *5.
44
law fraud. Damages were awarded under the benefit-of-the-bargain theory.237 The
court used a DCF method to value the business at the time of the sale less revenue
and expenses attributable to the lost customer’s business. The resulting actual value
was subtracted from the purchase price, which reflected the buyer’s expectation of
future revenue from the customer. The buyer’s damages were equal to the
difference.238
In Cobalt Operating, LLC v. James Crystal Enterprises, LLC, the defendant
seller was found to have fraudulently inflated the target business’s cash flows to
justify a $70 million purchase price, which had been set using a cash flow
multiple.239 The seller’s actions were contrary to its representations about the
legitimacy of its financial statements, among other representations. Then-Vice
Chancellor Strine described the “traditional method” of computing damages as that
reflecting the “reasonable expectations of the parties”; that is, “the amount of money
that would put the non-breaching party in the same position that the party would
237
Id. at *12.
238
In Tam, the purchase price was $103,500. Id. at *4. The same DCF method and
valuation date used to arrive at the purchase price was applied, less revenues and expenses
attributable to the lost customer. Id. at *12. This calculation yielded an adjusted value for
the business of $58,210. Id. Because the plaintiff “overpaid” by $45,290 ($103,500 minus
$58,210), the purchase price was “adjusted downward” to $58,210. Id. The plaintiff had
already paid $59,875.37 to the defendant. Damages were the difference of $1,665.37. Id.
239
2007 WL 2142926, at *29-30 (awarding damages using a valuation based on
expectations of future cash flows).
45
have been in had the breach never occurred.”240 He determined that the business’s
actual value was $59 million, resulting in $11 million of damages when compared
to the $70 million purchase price.241
Most recently, in Maverick Therapeutics, Inc. v. Harpoon Therapeutics, Inc.,
Vice Chancellor Glasscock found that a seller committed “fraud in the sale of a spin-
off designed to develop anti-cancer technology.”242 The fraud involved
misrepresentations about non-compete protections “the new entity would enjoy from
competing with its parent and [the] seller,” since the seller had formed a competing
product.243 The court assessed the plaintiff’s damages by comparing two values:
“what [the plaintiff] thought it had purchased, and what it actually got as a result of
[the seller’s] fraud.”244 The former value was the “negotiated value” of the plaintiff’s
investment.245 The latter value reflected losses the plaintiff would experience from
entering a market in competition with the seller. The plaintiff’s damages were the
240
Id. at *29 (citing Duncan, 775 A.2d at 1022).
241
Id. at *30. The award was payable by canceling the defendant’s $2 million equity
interest in the plaintiff and a $5 million promissory note. Damages of $4 million were
awarded. Id.
242
2021 WL 1592473, at *1.
243
Id.244
Id.245
Id. at *12-13 (“The parties, in an arm’s-length transaction between sophisticated entities
represented by counsel, had no trouble valuing Millennium’s investment as of 2017 with
the broad non-compete Millennium expected.”).
46
difference between the two, “discounted by what a buyer would pay to avoid the
possibility of such competition.”246
Delaware courts have also awarded expectation damages measured by lost
profits rather than lost business value.247 In PharmAthene, Inc. v. SIGA
Technologies, Inc., the defendant breached a contractual obligation to negotiate the
final terms of a license agreement for an early-stage drug in the event that a proposed
merger failed.248 After terminating the merger agreement and learning that the drug
could be more profitable than anticipated, the defendant declined to negotiate the
license and proposed terms different from those in the parties’ initial term sheet.
Vice Chancellor Parsons found it reasonably certain that the plaintiff lost profits due
to the defendant’s bad faith conduct.249 He awarded $133 million in damages, based
on earnings the plaintiff could have expected from drug sales had the defendant
executed the license agreement.250 The Delaware Supreme Court affirmed.
246
Id. at *13.
247
See PharmAthene, Inc. v. SIGA Techs., Inc., 2014 WL 3974167 (Del. Ch. Aug. 8, 2014)
(“One measure of expectation damages is a party’s lost profits.”), aff’d, SIGA II, 132 A.3d
1108.
248
SIGA II, 132 A.3d at 1117-18.
249
Id. at 1131.
250
The term sheet established a revenue-based royalty payment, set out a profit split, and
addressed other amounts to be paid if milestones were met. Id.
47
Although “[d]iminution of value, a backward-looking measure of damages, is
fundamentally different from lost profits, a forward-looking measure,”251 both
promote the same end. The objective is to restore the injured party to the
economically equivalent position it would have held absent the injury.252 Benefit-
of-the-bargain damages using either approach can remedy future harm to a
business.253
Here, Cloud Jumper led NetApp to believe that the Software Business was
more robust than it was. Cloud Jumper represented that it had $13,461,450 of total
revenue for 2019, with the Software Business responsible for $2,498,164.254 The
Internal Billings accounted for $1,087,366 of the latter figure, representing 8% of
251
Powers v. Stanley Black & Decker, Inc., 137 F. Supp. 3d 358, 386 (S.D.N.Y. 2015)
(citing Tractebel Energy Mktg., Inc. v. AEP Power Mktg., Inc., 487 F.3d 89, 109 (2d Cir.
2007)).
252
See, e.g., id. (“[W]here the seller makes misrepresentations about the business he is
selling, the natural and probable result is that the business is actually worth less than the
buyer paid, and diminution of value damages therefore compensate the buyer for ‘the value
of the promised performance.’” (quoting Schonfeld v. Hilliard, 218 F.3d 164, 176 (2d Cir.
2000)); WaveDivision, 2010 WL 3706624, at *22 (observing that “[b]ecause a buyer often
intends to operate a business in a way that will change its cash flows, its expectancy
damages are the profits it expected to make, if it can prove them with reasonable
certainty”).
253
See Cobalt, 2007 WL 2142926, at *27 (describing the plaintiff’s harm from materially
misleading representations about the accuracy of financial statements concerning annual
cash flow as affecting earnings on a going-forward basis).
254
Kleinrichert Revised Opening Rep. 24.
48
Cloud Jumper’s revenues or 43.5% of its Software Business revenues.255 This did
not amount to a one-time loss for NetApp, but would continue to affect future cash
flows. In these circumstances, dollar-for-dollar damages would not make NetApp
whole.256
With that framing, I consider the parties’ respective damages estimates.
2. The Experts’ Damages Calculations
NetApp seeks to recover damages based on the stream of future cash flows it
expected to generate by acquiring Cloud Jumper. NetApp estimates that Cloud
Jumper’s fraud and breaches of contract caused it to lose future cash flows worth
$37.7 million on a present value basis.257 The defendants reject NetApp’s approach
and focus on the diminution in Cloud Jumper’s value attributable to the
255
The overstatement as a percentage of Cloud Jumper’s total annual revenue was 8%
percent in 2019 and 4% in 2018. See Hughes Tr. 587-88.
256
Cf. Universal Enters. Grp. LP v. Duncan Petroleum Corp., 2013 WL 3353743, at *1,
*20 (Del. Ch. July 1, 2013) (observing that environmental issues contrary to
representations in an asset purchase agreement did “not appear to have translated into
unsafe operations or environmental spills” and awarding dollar-for-dollar damages equal
to the costs the plaintiff incurred in remediating the environmental conditions of subject
properties); Zayo, 2018 WL 6177174, at *16 (discussing that the loss of short-term
customer relationships, which purportedly breached a stock purchase agreement, did not
diminish the business’s value in an amount greater than the out-of-pocket loss represented
by the lost contract revenue); see also Ass’n of Int’l Certified Pro. Accts., Forensic &
Valuation Services Practice Aid: Mergers & Acquisitions Disputes 58 (2020) (updated Jan.
1, 2020) (“Claims that result in dollar-for-dollar damages are typically those that have a
one-time effect on the target and that do not impact the target financial condition in future
periods (in other words, will not affect future cash flows).”).
257
See Pl.’s Post-trial Opening Br. 42.
49
misrepresented software revenue, which supports a maximum recovery of
approximately $4.6 million.258 Each position is supported by an expert opinion.
a. Hickey’s Analysis
NetApp’s damages estimate relies upon the expert opinion of George S.
Hickey.259 Hickey performed a single analysis.260 He calculated NetApp’s
expectations for Cloud Jumper as a unit of NetApp using Cloud Jumper’s projected
cash flow plus synergistic cash flow. From that number, he subtracted the value of
future cash flows that NetApp actually received, adjusting for the Internal Billings.
He did not assess the value of Cloud Jumper on a standalone basis.261
Hickey employed a three-step approach using a DCF methodology.262 First,
he replicated NetApp’s valuation analysis at the time of the deal using the Combined
Projections. NetApp’s analysis valued Cloud Jumper using a DCF model based on
expected future cash flows for 2020 to 2024 derived from Cloud Jumper’s
258
See Defs.’ Post-trial Br. 57.
259
Hickey is a senior vice president at Yilmaz Advisory with 25 years of experience in
economic consulting focusing on M&A disputes and other transactions. He has served as
a consulting expert in matters before the Court of Chancery about a dozen times. See
Hickey Opening Rep. ¶¶ 1-2.
260
See Expert Rebuttal Report of Gary Kleinrichert (Dkt. 85; JX 333) (“Kleinrichert
Rebuttal Rep.”) 3. Hickey also provided a rebuttal opinion critiquing the defendants’
expert’s analyses. Expert Rebuttal Report of George S. Hickey (Dkt. 85; JX 332) (“Hickey
Rebuttal Rep.”).
261
Hickey Tr. 730-31.
262
Id. at 681-82.
50
Management Projections, as revised by NetApp. Hickey applied a terminal value
estimate assuming those cash flows would grow between 2.5% and 3.5% in
perpetuity and a weighted average cost of capital (WACC) range of 12.5% to
17.5%.263 Doing so resulted in future cash flows worth between $65.2 million and
$123.1 million on a present value basis, with a midpoint of $86.2 million.264
Second, Hickey adjusted NetApp’s Combined Projections to address Internal
Billings. Hickey reduced NetApp’s estimate of revenue synergies that could be
realized from the acquisition, which he calculated to be inflated by approximately
42% from Internal Billing.265 Removing the Internal Billings resulted in future cash
flows worth between $36.4 million and $69.8 million on a present value basis, with
a midpoint of $48.5 million.266
Finally, Hickey calculated damages equal to the difference between these
estimates (or between $28.8 million and $53.3 million) on a present value basis. The
midpoint is $37.7 million.267 NetApp seeks that amount as damages.
263
Hickey Opening Rep. ¶ 47 (citing JX 93, “DCF” tab).
264
Id. ¶¶ 48, 53. $86.2 million represents the midpoint of WACC and perpetuity growth
rate assumptions—i.e., a 3% growth rate and a 15% WACC. See id. at Ex. 1 (perpetuity
growth rate and WACC table). The same applies for the midpoint analysis discussed infra
at notes 266-67 and accompanying text.
265
Id. ¶ 51, Tbl.9.
266
Id. ¶ 54.
267
Id. ¶ 55.
51
b. Kleinrichert’s Analyses
The defendants’ expert, Gary Kleinrichert, compared the $35 million purchase
price to what he determined to be Cloud Jumper’s fair market value as of the
April 28, 2020 closing.268 Kleinrichert arrived at his opinion of fair market value for
Cloud Jumper using several methods: an income approach, a market approach, an
adjusted “football field” analysis, and by assessing implied deal multiples of
revenue.269
Kleinrichert’s income approach used NetApp’s standalone DCF model for
Cloud Jumper, adjusted to account for the Internal Billings in Cloud Jumper’s
income statement.270 Kleinrichert first lowered projected software revenue based on
an estimate of annual Internal Billings. He then adjusted the gross margins for Cloud
Jumper’s Legacy and Software Businesses after removing the Internal Billings. He
applied a 15% WACC and a 3% perpetual growth rate, which were inputs adopted
268
Kleinrichert is a Certified Public Accountant, Certified Valuation Analyst, accredited
in business valuation, and certified in financial forensics. He is a senior managing director
in the Forensic and Litigation practice of FTI Consulting, Inc. and has over 35 years of
experience as an auditor and consultant in accounting, auditing, investigative, litigation,
and valuation matters. See Revised Kleinrichert Opening Rep. at 3.
269
Revised Kleinrichert Opening Rep. 4-8.
270
The income approach determines a value indication “based on the assumption that the
value of an ownership interest is equal to the sum of the present values of the expected
future benefits of owning that interest.” Id. at 26 (quoting James R. Hitchner, Financial
Valuation: Applications and Models 281 (4th ed. 2017)).
52
by NetApp when developing its own DCF analysis.271 Kleinrichert also corrected
an error in NetApp’s terminal value calculation based on its 2024 undiscounted free
cash flow estimate.272 Kleinrichert arrived at an indication of value for Cloud
Jumper of approximately $48.6 million using the income method.
Kleinrichert’s market approach valued Cloud Jumper based on guideline
public companies and guideline transactions methods.273 He identified several
public companies and transactions in the MSP and the VDI industries, from which
he calculated median multiples of enterprise value to revenue (EV/revenue).
Kleinrichert determined value through these methods by applying the median
revenue multiple he calculated for each industry to Cloud Jumper’s respective
revenue streams. He reached an indication of value of approximately $30.4 million
using the guideline public companies method and approximately $35.0 million using
the guideline transactions method.274
271
See id. at 27-32.
272
Kleinrichert Revised Opening Rep. at Sched. 3. The free cash flow number NetApp
used to calculate terminal value had already been discounted before NetApp again
discounted it to present value. See Hickey Tr. 737-38 (observing that NetApp should have
used $22.3 million for 2024 free cash flow rather than the $11.9 million it inputted).
273
The market approach is “a general way of determining a value indication of a business,
business ownership interest, security, or intangible asset by using one or more methods that
compare the subject to similar businesses, business ownership interests, securities, or
intangible assets that have been sold.” Kleinrichert Revised Opening Rep. 27 (quoting
NACVA, International Glossary of Business Valuation Terms (June 8, 2001),
http://www.nacva.com/glossary (defining Market (Market-Based) Approach)).
274
Id. at 5, 7-8.
53
Kleinrichert weighted his conclusion of value toward the market approach
over the income approach.275 He calculated the difference between the purchase
price and a fair market value of Cloud Jumper ranging from $30.4 million to $35.0
million. He concluded that NetApp’s damages are $0 to $4.6 million.276
Kleinrichert prepared two other analyses that did not factor into his damages
estimate. First, he prepared an adjusted version of the “football field” chart that the
NetApp deal team presented to secure Investment Committee approval for an LOI.277
NetApp’s original chart included the four valuation methodologies NetApp had
considered: a standalone DCF using the Standalone Projections, a combined DCF
(including synergistic value) using the Combined Projections,278 a guideline
transactions analysis, and a guideline public companies analysis. Kleinrichert’s
revised football field included the three indications of value he calculated plus an
adjusted DCF that considered estimated synergies and the effect of Internal
Billing.279 Based on this chart, Kleinrichert opined that the $35 million purchase
275
Id. at 38.
276
Kleinrichert believed that NetApp’s own “football field” chart and an implied multiple
analysis, among other things, supported the low end of this range as a reasonable estimate
of damages. Id. at 8; see also Expert Report of Gary Kleinrichert (Dkt. 85; JX 330)
(“Kleinrichert Opening Rep.”) at Sched. 1.0.
277
See JX 129 at 19.
278
See infra Section II.C.2.a.i. (discussing synergistic value).
279
See Kleinrichert Revised Opening Rep. 39-41, Updated Sched. 7.0. Kleinrichert’s
combined DCF analysis left NetApp’s other assumptions unchanged. Id. at 40-41.
54
price remains within or below the range of valuation methods considered by NetApp
after adjusting for Internal Billing.280
Finally, Kleinrichert analyzed the implied deal multiples from the Cloud
Jumper acquisition as another indication of value. Based on the $35 million
purchase price and the 2019 revenues Cloud Jumper disclosed to NetApp, NetApp
purchased Cloud Jumper at a 2.6x EV/revenue multiple. Kleinrichert’s concluded
that this blended multiple falls within an acceptable range of comparable
multiples.281 When Cloud Jumper’s 2019 revenue is adjusted for Internal Billing,
the multiple increases to 2.8x revenue, which is within the range of multiples
considered by NetApp in its contemporaneous valuation analysis.282 Damages based
on an application of the original implied deal multiple to the 2019 Internal Billings
would be $2.83 million.283
3. Assessment of the Parties’ Damages Estimates
The record establishes that NetApp was damaged by relying on Cloud
Jumper’s representations about the accuracy of its financial statements.284 NetApp
280
Id. at 41.
281
Id. at 42-43; see Kleinrichert Opening Rep. at Scheds. 4.0 & 5.0.
282
Kleinrichert Revised Opening Rep. 43.
283
Id. This figure is calculated by applying the 2.6x implied multiple to the 2019 Internal
Billing revenue of $1,087,366 for a difference of $2,827,169. Id. at 44; see Kleinrichert
Opening Rep. at Sched. 6.1.
284
See supra Section II.B.5.
55
strategically acquired Cloud Jumper to grow in the VDI space, but Cloud Jumper’s
Software Business revenues were meaningfully lower than NetApp was led to
believe. Had NetApp known about the Internal Billing, it would not have purchased
Cloud Jumper—at least not for $35 million.285
My task, then, is to determine the appropriate remedy. As discussed below, I
decline to adopt NetApp’s damages estimate. Hickey’s analysis is imprudent, and
his damages conclusion would deliver a windfall to NetApp.
Instead, I assess NetApp’s damages based upon the diminution in value it
experienced because of Cloud Jumper’s misrepresentations. Kleinrichert’s analysis
is not faultless, but his guideline public companies method yields a credible estimate
of lost business value.286
a. NetApp’s Estimate
NetApp’s approach is facially appealing. It considers NetApp’s expectations
for how Cloud Jumper would perform as a unit of NetApp, including revenue
synergies. Yet I cannot adopt it for two reasons. First, the record lacks any tangible
facts to support a reasonable inference that NetApp would have achieved the
285
See Lye Dep. 227; Mitzenmacher Tr. 188-89, 367.
286
Kleinrichert’s relatively superior experience in calculating benefit-of-the-bargain
damages gives added credibility to his approach. See supra notes 259, 268; Zayo, 2018
WL 6177174, at *15 n.196 (describing Kleinrichert’s “significant experience in benefit-of-
the-bargain damages and business valuation”).
56
theoretical synergies it projected. Second, NetApp’s estimate is not limited to the
harm proximately caused by Cloud Jumper’s fraud and breaches of contract.
i. Speculative Synergies
NetApp’s estimate includes post-closing synergistic cash flows it hoped to
attain by increasing sales of Cloud Jumper software using NetApp’s larger sales
force and by leveraging Cloud Jumper’s VDI product with complementary NetApp
products. In NetApp’s view, it is entitled to recover the value of these projected
synergies, adjusted for the effect of Internal Billing on the combined entity.
“Synergy is the potential additional value from combining two firms.”287
Synergies may arise from multiple potential sources, such as a reduction of average
costs or revenue upside from a more productive use of assets.288 The potential to
create synergistic value between two previously separate businesses is often a
driving factor in business combinations.289 Prospective corporate synergies involve
287
Aswath Damondaran, Investment Valuation: Tools and Techniques for Determining the
Value of Any Asset 707 (3d ed. 2012); Merion Cap. LP v. BMC Software, Inc., 2015 WL
6164771, at *14 (Del. Ch. Oct. 21, 2015) (describing synergies as “value arising solely
from the deal”); Mitzenmacher Dep. 51.
288
See, e.g., J. Myles Shaver, A Paradox of Synergy: Contagion and Capacity Effects in
Mergers and Acquisitions, 31 Acad. Mgmt. Rev. 962, 962-63 (2006).
289
See WaveDivision, 2010 WL 3706624, at *23 n.151; see also Cinerama, Inc. v.
Technicolor, Inc., 663 A.2d 1134, 1143 (Del. Ch. 1994) (“The components of value in an
acquisition might be considered to be two: the going concern value of the firm as currently
organized and managed and the ‘synergistic value’ to be created by the changes that the
bidder contemplates (e.g., new management, cost efficiencies, etc.).”), aff’d, 663 A.2d
1156 (Del. 1995).
57
predictions about the unpredictable process of integrating a new business into an
existing one. These unknowns may result in an overvaluation of synergies, which
can take longer to capture than anticipated—if they are captured at all.290
Here, there is no evidentiary basis from which I can make a “responsible
estimate” of lost synergistic cash flows.291 Mathematical certainty is not required
“where a wrong has been proven and injury established.”292 Nonetheless, the court
cannot award damages based on “speculation or conjecture.”293 An award of
expectation damages “presupposes that the plaintiff can prove damages with
reasonable certainty.”294
290
See generally Mark L. Sirower & Jeffery M. Weirens, The Synergy Solution: How
Companies Win the Merger & Acquisitions Game (2022) (analyzing mergers over a 24
year period and observing that most acquirers realized negative average returns and failed
to achieve expected synergies); Scott A. Christofferson et al., Where Mergers Go Wrong,
McKinsey Q. (May 1, 2004) (available at https://www.mckinsey.com/capabilities/strategy-
and-corporate-finance/our-insights/where-mergers-go-wrong) (observing that 70% of
mergers fall short of achieving targets for revenue synergies).
291
Beard Rsch., Inc. v. Kates, 8 A.3d 573, 613 (Del. Ch. 2010), aff’d, 11 A.3d 749 (Del.
2010).
292
Id. (quoting Del. Express Shuttle, Inc. v. Older, 2002 WL 31458243, at *15 (Del. Ch.
Oct. 23, 2002)); see also SIGA II, 132 A.3d at 1111 (“The amount of damages can be an
estimate.”).
293
Acierno v. Goldstein, 2005 WL 3111993, at *6 (Del. Ch. Nov. 16, 2005); see also Great
Hill Equity P’rs IV, LP v. SIG Growth Equity Fund I, LLLP, 2020 WL 948513, at *23 (Del.
Ch. Feb. 27, 2020) (awarding no damages related to misrepresentations where the plaintiffs
“could have, but did not, provide a non-speculative way to quantify damages”); Frontier
Oil v. Holly Corp., 2005 WL 1039027, at *39 (Del. Ch. Apr. 29, 2005) (“[A]bsolute
precision is not required but the proof may not be speculative either.”).
294
SIGA Techs., Inc. v. PharmAthene, Inc., 67 A.3d 330, 351 n.99 (Del. 2013) (citing
Callahan v. Rafail, 2001 WL 283012, at *1 (Del. Super. Mar. 16, 2001)); Callahan, 2001
58
NetApp maintains that the Combined Projections provide adequate support
for its expectation damages.295 In preparing the Combined Projections, NetApp
identified two types of synergies and created forecasts for each.296 NetApp avers
that these forecasts are the best evidence of the value it expected to receive from
Cloud Jumper—including synergistic value.297
I disagree. To assess whether NetApp reasonably expected to realize the
synergies it layered on top of the Standalone Projections would be a theoretical
exercise.298 NetApp’s predictions were aspirational. Its financial due diligence
report noted that NetApp’s revenue team did not evaluate NetApp’s valuation model,
including whether “synergies made any sense.”299 The report also remarked that
Cloud Jumper would need “heavy support from [the] NetApp cloud sales team to
WL 283012, at *1 (“It is well-settled law that a recovery for lost profits will be allowed
only if their loss is capable of being proved, with a reasonable degree of certainty. No
recovery can be had for loss of profits which are determined to be uncertain, contingent,
conjectural, or speculative.” (citation omitted)).
295
Pl.’s Post-trial Opening Br. 46.
296
See Hickey Tr. 689-94; JX 129 at 39.
297
See Mitzenmacher Tr. 124-25; Hickey Tr. 694.
298
See Mitzenmacher Tr. 197-99; see also JX 78.
299
JX 259 at 9.
59
drive growth and adoption in order to achieve the aggressive [s]ynergies modeled in
the financial DCF valuation.”300
Hickey’s analysis does little to ground NetApp’s estimate. Hickey did not test
NetApp’s synergy calculations or opine on their reasonableness, but wholesale
adopted NetApp’s assumptions.301 Using an erroneous model that would have raised
NetApp’s damages calculation by nearly $20 million if corrected further reveals the
imprudence of his approach.302
NetApp attempts to overcome the conjectural nature of this analysis by
appealing to the “wrongdoer rule,” which provides that uncertainty in a damages
300
See id. at 9, 12, 45. The due diligence report also notes that NetApp’s revenue team did
not perform diligence on the NetApp model or whether the synergies were supportable. Id.
at 9.
301
In fact, events post-closing suggest that NetApp’s predictions were unreasonable. See
infra notes 316-23 and accompanying text.
302
The NetApp model Hickey used included a reference error that understated the terminal
value. See supra note 272. Although Hickey discovered the error after the exchange of
opening expert reports and identified the issue in his rebuttal report, he—unlike
Kleinrichert—declined to revise his model to correct it. Changing the cell reference would
have increased the calculation of Cloud Jumper’s total enterprise value to approximately
$133 million, or $75 million adjusting for Internal Billing. That would mean Hickey’s
estimated damages would rise to $58 million. See Hickey Tr. 705-07.
Hickey testified that he made a principled decision not to incorporate the corrected
values into his analysis. He reasoned that NetApp’s contemporaneous expectations relied
on the flawed data and he believed that by not correcting for the error, he would put forth
a “more conservative” measurement. Id. at 706-07. Regardless, NetApp’s Combined
Projections were wrong and so is Hickey’s analysis.
60
estimate should be construed against the breaching party.303 Resolving uncertainty
against Cloud Jumper does not relieve NetApp of its burden to present expectation
damages that are not speculative.304 Moreover, the pervasive uncertainty in the
Combined Projections is not a result of Cloud Jumper’s misrepresentations;305 it is
due to NetApp making optimistic predictions about the unknown. Whether NetApp
would deliver on its prognostications depended on how NetApp operated the
combined entity—a matter squarely in NetApp’s hands.
303
SIGA II, 132 A.3d at 1131 n.132 (“Courts in Delaware and other jurisdictions have
frequently applied the ‘wrongdoer rule’ where the wrongdoer’s breach contributed to
uncertainty over the amount of damages.”); Am. Gen. Corp. v. Cont’l Airlines Corp., 662
A.2d 1, 10 (Del. Ch. 1992) (explaining that if a defendant’s wrongful conduct contributed
to uncertainty in the calculation of damages, “the perils of such uncertainty should be ‘laid
at the defendant’s door’” (quoting Madison Fund, Inc. v. Charter Co., 427 F. Supp. 2d 597,
608 (S.D.N.Y. 1977))); Maverick II, 2021 WL 1592473, at *10 (“A moment’s reflection
demonstrates that the perpetrator of an intentional tort should not get the benefit of
uncertainty in the quantum of harm he has caused.”).
304
See Duncan, 775 A.2d at 1023-24 n.12 (observing that the risks of uncertainty
surrounding future events that are “impossible to know” should not be resolved against the
defendant); Madison Fund, 427 F. Supp. 2d at 608 (“This Court simply cannot credit
plaintiff with market prescience. And, as the Supreme Court has observed, ‘even where
the defendant by his own wrong has prevented a more precise computation, the (factfinder)
may not render a verdict (with respect to damages) based on speculation or guess-work.’”
(quoting Bigelow v. RKO Radio Pictures, 327 U.S. 251, 264 (1946))); Del. Express Shuttle,
2002 WL 31458243, at *15 (emphasizing that “[s]peculation is an insufficient basis” for a
damages award).
305
Compare SIGA II, 132 A.3d at 1111 (“When a party breaches a contract, that party often
creates a course of events that is different from those that would have transpired absent the
breach. The breaching party cannot avoid responsibility for making the other party whole
simply by arguing that expectation damages based on lost profits are speculative because
they come from an uncertain world created by the wrongdoer.”).
61
Finally, NetApp contends that Delaware courts have awarded damages based
on estimated profits the buyer could have gained absent the seller’s breach.306 But
the case NetApp mainly relies on highlights the fault in NetApp’s position. In
WaveDivision Holdings, LLC v. Millennium Digital Media Systems, L.L.C., a jilted
buyer was awarded damages equivalent to the value it expected to receive by
purchasing certain cable systems less any costs avoided by not having to perform.307
The court’s EBITDA multiple analysis relied upon a set of base case projections the
plaintiff provided to its bank for deal financing, which applied growth rates from the
buyer’s previous successes to calculate future earnings for the systems. These
projections provided a “sound, conservative estimate” of growth in operating cash
flows the plaintiff could have expected by acquiring the cable systems.308 The
estimates had “the added benefit of having been relied upon by a party—the bank—
with a strong interest in getting repaid” and were in line with earlier projections of
operating cash flows.309
306
See WaveDivision, 2010 WL 3706624, at *22 (awarding damages based on the
difference between what the buyer expected to generate and what it could have expected if
the seller had been truthful); see also SIGA II, 132 A.2d at 1111 (affirming an award of
expectancy damages based on lost profits from the failure to negotiate an agreement in
good faith); Harrington v. Hollingsworth, 1992 WL 91165, at *4 (Del. Super. Apr. 15,
1992) (awarding lost profits); Mobile Diagnostics, Inc. v. Lindell Radiology, P.A., 1985
WL 189018, at *4 (Del. Super. July 29, 1985) (same).
307
2010 WL 3706624, at *22.
308
Id. at *23.
309
Id.
62
The record before me is devoid of similarly reliable evidence to support
NetApp’s projected future cash flows. The Cloud Jumper Management Projections
that NetApp used to create the Standalone and Combined Projections were unrefined
and doubled software revenue year-over-year based on a single year of earnings
data.310 The haircuts NetApp applied to the Management Projections were
immaterial.311 Contemporaneous documents suggest that NetApp personnel viewed
the revenue projections as aggressive.312
At bottom, NetApp’s calculation is unsound. “Damages are not recoverable
for loss beyond an amount that the evidence permits to be established with
reasonable certainty.”313 I therefore reject NetApp’s $37.7 million damages
estimate.
310
JX 78.
311
See Hickey Opening Rep. ¶¶ 26-28, 33 n.51; JX 93.
312
See Kleinrichert Rebuttal Rep. 10-11; JX 506 at 3 (discussing Cloud Jumper’s revenue
modeling as “very aggressive” and observing “the revenue transition slowing the total
growth, not accelerating”); JX 259 at 9 (“Revenue team hasn’t performed diligence over
the [Cloud Jumper] historics (are the numbers just made up, do the contracts tie to ledgers)
or the NetApp model (do the growth rates, valuation approaches and synergies make any
sense).”); id. at 45 (discussing that Cloud Jumper “growth estimates . . . may need to be
revised downwards once the emergency situation is resolved”); id. at 12 (observing that
Cloud Jumper revenue model “increase[s] by 3X from $13M to $40M in 3 years” which
“[s]eem[ed] aggressive”).
313
Restatement (Second) of Contracts § 352 (“The main impact of the requirement of
certainty comes in connection with recovery for lost profits.”).
63
ii. Lack of Proximate Cause
NetApp’s estimate cannot be adopted for a second reason: it would allow
NetApp to recover for lost value unrelated to Cloud Jumper’s misstatements.
Damages for a tort are “broader, more flexible, and more encompassing than the
remedy for a breach of contract, even when expectancy is the measure.”314
Nevertheless, damages are generally limited to those “resulting from the direct and
natural consequence of [the plaintiff] acting on the strength of the defendant’s
statements.”315 NetApp’s requested damages go further.
Hickey focuses on two categories of synergies that NetApp contemplated
while pursuing Cloud Jumper. The first are “Software Uplift Synergies,” which are
revenue synergies NetApp anticipated from selling a higher volume of Cloud Jumper
software through NetApp’s sales channels and larger sales force. The second
category, “Other Synergies,” were incremental revenues NetApp hoped to realize by
selling more of its preexisting storage products with added functionality from Cloud
Jumper’s software. The Software Uplift and Other Synergies account for a
substantial portion of the cash flows Hickey calculated as damages.
P’rs & Simon, Inc. v. Sandbox Acqs., LLC, 2021 WL 3159883, at *5 (Del. Ch. July 26,
314
2021) (ORDER).
315
LCT Cap., 249 A.3d at 91 (quoting Stephenson, 462 A.2d at 1077).
64
I cannot conclude that any loss of value associated with these synergies was
proximately caused by Cloud Jumper’s fraud. NetApp understood that achieving
the Combined Projections required it to bring “much of the value in the solution.”316
In other words, NetApp “own[ed] all the risk of execution.”317 It failed to deliver.318
Just four months after closing, NetApp decided to end-of-life Cloud Jumper’s
VDI product.319 NetApp never attempted new sales of Cloud Jumper software, even
though the product performed as expected.320 It retained Cloud Jumper’s existing
customers, intellectual property, and personnel.321 The Cloud Jumper engineering
team was moved to develop a new VDI product within Spot—another (significantly
larger) company acquired by NetApp.322 In such circumstances, awarding NetApp
damages in excess of the purchase price would amount to a windfall.323
316
Mitzenmacher Tr. 251-52, 257; see also Avadhanam Dep. 94-96, 133.
317
Mitzenmacher Dep. 50-51.
318
See SIGA II, 132 A.3d at 1133 (observing that the trial court appropriately used limited
post-breach evidence “to confirm its conclusions as to the parties’ reasonable expectations
at the time of the breach”).
319
See Lye Dep. 229; see also id. at 53-54.
Picarello Tr. 82-83; Mitzenmacher Tr. 359-60 (“[T]he product wasn’t defective in any
320
way.”).
321
See Lye Dep. 230; JX 298 at 63 (assigning values to assets retained from Cloud Jumper).
322
See Lye Dep. 229; Picarello Dep. 17-18; Picarello Tr. 71; see also JX 298 at 35 (showing
that NetApp acquired Spot for $340 million on July 9, 2020).
323
See, e.g., Paul v. Deloitte & Touche, LLP, 974 A.2d 140, 146 (Del. 2009) (stating that
breach of contract damages should not provide a “windfall” to the plaintiff).
65
b. The Defendants’ Estimate
NetApp asserts that the court should reject Kleinrichert’s analysis because “a
DCF analysis is the only way to evaluate the Internal Billings’ effect on NetApp’s
expectations for the combined entity.”324 This belief is incorrect.325 It is also belied
by the record. Contemporaneous documents show that NetApp viewed market
multiples as a more accurate measure of value for a startup like Cloud Jumper than
a DCF method.326 NetApp’s DCF analysis is especially unreliable given the error in
the input of the terminal value of free cash flow.327
Consistent with Delaware law and the facts of this case, Kleinrichert
compared the value of Cloud Jumper that NetApp expected ($35 million) to the value
324
Pl.’s Post-trial Reply Br. 28.
325
See supra at notes 234-35 and accompanying text; see also WaveDivision, 2010 WL
3706624, at *23 (noting that projections “could be used to perform either a DCF analysis
or a multiple of EBITDA analysis” and rejecting an argument that the court should not
“deviate from the ‘standard’ DCF analysis”); Shannon P. Pratt & Alina V. Niculita,
Valuing a Business: The Analysis and Appraisal of Closely Held Companies 262 (5th ed.
2008) (“The use of comparable publicly held corporations as a guide to valuation, as a
practical matter, may be the most important and appropriate technique for valuing a
privately held operating business.” (citation omitted)).
326
JX 189 (“The reason we use triangulation in valuing startups is that market based
multiples are usually more accurate measures of value in an acquisition than DCF, which
is conjuncture [sic], in best of cases.”); see also JX 500 (“Valuation is a triangulation with
[m]arket comps as a crucial component, precisely because DCF is not an exact science.”);
JX 187 at 2 (“Sorry to say this, but with tweaking the inputs into a P&L and the discount
rate, I can produce almost any DCF value for any business. . . . Again, this is also the
reason we use a market[-]based approach to validate the DCF work.”).
327
See Hickey Rebuttal Rep. 19-21 & n.44.
66
that it received in February 2020. As previously described, Kleinrichert’s market
approach used revenue multiples to calculate the value of Cloud Jumper after
correcting for Internal Billing. His analyses yielded an actual value of $30.4 million
using the guideline public companies method and $35.0 million using the guideline
transactions method.
Kleinrichert’s use of a revenue multiple is appropriate.328 A company like
Cloud Jumper that experiences negative earnings during its early operational stages
can have positive market value where investors believe it will achieve earnings and
cash flow in the future.329 NetApp calculated its expectations for Cloud Jumper
using an EV/revenue multiple.330
Nonetheless, I decline to adopt Kleinrichert’s guideline transactions analysis.
At the time of the acquisition, VDI companies traded at considerably higher
multiples than MSP companies.331 But Kleinrichert’s guideline transactions analysis
328
See Kleinrichert Tr. 828 (“I don’t think there’s any dispute about using a revenue
multiple.”); see also Aswath Damodaran, Investment Valuation: Tools and Techniques for
Determining the Value of Any Asset 542-43 (3d ed. 2012) (explaining that “[f]or young
firms that have negative earnings, multiples of revenues have replaced multiples of
earnings” to value companies); id. (describing revenue multiples as “attractive” for reasons
including their availability for “very young firms”).
329
See Kleinrichert Revised Opening Rep. 33-34.
330
See, e.g., JX 93.
331
See Hickey Rebuttal Rep. ¶¶ 39-40.
67
resulted in a median EV/revenue multiple of 2.5x for VDI transactions—a figure
that is lower than the 2.9x multiple he observed for MSP transactions.332
Kleinrichert’s guideline public companies method does not suffer from the
same defect. It indicates a median EV/revenue multiple of 4.96x for the VDI
companies and a 2.13x multiple for the MSP companies he selected.333 Kleinrichert
calculated a blended multiple of 2.46x, which falls on the lower end of the range of
blended multiples NetApp estimated for guideline public companies—adjusted for
Internal Billing—of 2.3x to 4.3x.334 Using a blended multiple is not only consistent
with NetApp’s contemporaneous analysis, but also reflects its expectation that Cloud
Jumper MSP customers would become VDI customers.335
Further, the defendants have met their burden of showing that the guideline
companies considered in this analysis are appropriate comparables for Cloud
Jumper.336 Kleinrichert’s selection of guideline companies resulted from a
332
See id. ¶ 40 & Fig.1.
333
Kleinrichert Opening Rep. at Sched. 4.1; see also Kleinrichert Revised Opening Rep.
33 & n.166.
334
See Kleinrichert Opening Rep. at Scheds. 4.0 & 4.2. The public company multiples
considered by NetApp, as adjusted based on a revised 2019 revenue mix, were: 2.30x (low
end), 3.30x (median), and 4.30x (high end). See id. at 42, Sched. 6.1; see also JX 93
(“Football Field” Tab) (listing “trading comps” multiples as 2.7x (low end), 3.7x (median),
4.7x (high end)).
335
See Kleinrichert Tr. 837-39.
336
See In re Cellular Tel. P’ship Litig., 2022 WL 698112, at *30 (Del. Ch. Mar. 9, 2022).
68
reasonable and thorough process.337 Two of the four VDI and two of the four MSP
companies he chose overlap with the trading comparables identified by NetApp.338
Kleinrichert did not adopt the other guideline companies NetApp identified; he
selected four other public companies (two MSP and two VDI) based on his
research.339
The guideline companies included in Kleinrichert’s analysis are substantially
larger than Cloud Jumper and (unlike Cloud Jumper) have generated EBITDA. But
perfect comparables do not exist. Like other assumptions in valuation methods, the
selection of guideline companies is more an art than a science.340 The gross profit
337
Kleinrichert Tr. 830-31 (describing his research of public companies, review of
company descriptions, and comparison of businesses most relevant to assessing Cloud
Jumper); Kleinrichert Opening Rep. 5 & Scheds. 4.1-4.3.
338
Compare JX 93 (“Trading Comps Output” Tab) (listing Citrix Systems, VMWare, Inc.,
Microsoft Corporation, and Hewlett Packard Enterprise as VDI comparables; and
Accenture plc, Cognizant Technology Solutions Corporation, Infosys Ltd., Tata
Consultancy Services as MSP comparables) with Kleinrichert Opening Rep. at Sched. 4.2
(listing Citrix Systems, VMWare, Inc., Oracle, and Nutanix, Inc. as VDI comparables; and
Internal Business Machines Corporation (IBM), Cognizant Technology Solutions
Corporation, Accenture plc, and DXC Technology Company as MSP comparables).
339
Kleinrichert Tr. 828-29.
340
See In re S. Peru Copper Corp. S’holder Deriv. Litig., 52 A.3d 761, 816 (Del. Ch. 2011)
(noting that determining an appropriate valuation “is not a straightforward exercise and
inevitably involves some speculation”); Answath Damodaran, Damodaran on Valuation:
Security Analysis for Investment and Corporate Finance 236 (2d ed. 2006) (“[T]he lack of
transparency regarding the underlying assumptions in relative valuations makes them
particularly vulnerable to manipulation.”); see also Kleinrichert Tr. 806-07, 828-31, 834-
36; Avadhanam Dep. 131-32 (“There are never perfect comparables for any business.”);
id. at 133, 209-11.
69
NetApp is entitled to recover the diminution in value resulting from Cloud Jumper’s
fraud and breaches of contract. This figure is calculated by subtracting the actual
value of Cloud Jumper ($30,401,022) from the value of Cloud Jumper as represented
to NetApp (the $35,000,000 purchase price). The difference is $4,598,978, which I
award to NetApp as damages.343
D. Attorneys’ Fees
Finally, NetApp seeks an award of attorneys’ fees and costs. Section 10.10
of the Merger Agreement provides: “If a claim or dispute brought in accordance
herewith is resolved in the favor of a Party hereto, such Party shall be entitled to,
and awarded, its costs and expenses incurred in connection with the resolution of
such claim or dispute (including reasonable attorneys’ fees).”344
The defendants do not challenge the application of this provision. Rather,
they contend that it supports an award of their own fees. 345 Given that NetApp’s
claims have been resolved in its favor, it is entitled to an award of costs and expenses
(including reasonable attorneys’ fees) under Section 10.10.
343
It bears noting that this amount is at the high end of NetApp’s contemporaneous estimate
of its losses upon discovering the Internal Billing. Mitzenmacher adjusted NetApp’s pre-
LOI transaction and trading comparable analyses to correct for the effect of Internal Billing
on NetApp’s valuation of Cloud Jumper. He calculated “$2.5M-$5M of valuation impact
based on multiples.” JX 288 at 5.
344
Merger Agreement § 10.10.
345
Defs.’ Post-trial Br. 59.
71
III. CONCLUSION
Consistent with the above, judgment is entered in favor of NetApp. NetApp
is entitled to an award of damages totaling $4,598,978. NetApp is also entitled to
interest at the legal rate starting on November 20, 2020,346 and to an award of its
reasonable fees and expenses. The parties shall confer on a form of final order and
file it within 14 days.
346
See Citadel Hldg. Corp. v. Roven, 603 A.2d 818, 826 (Del. 1992) (“In Delaware,
prejudgment interest is awarded as a matter of right.”). “The Court of Chancery generally
looks to the legal rate of interest, as set forth in 6 Del. C. § 2301, as the ‘benchmark’ for
the appropriate rate of pre- and post-judgment interest.” Murphy Marine Servs. of Del.,
Inc. v. GT USA Wilm., LLC, 2022 WL 4296495, at *24 (Del. Ch. Sept. 19, 2022) (citation
omitted).
72