Fraud claims permeate transactions for the sale of assets, stock, and other business interests. More often than not, litigation involves the purchaser in these transactions seeking to challenge or undo the deal by alleging that the seller misrepresented or concealed material facts that directly impacted the buyer’s decision to purchase the subject of the transaction. Much of the litigation that these transactions spawn, however, could be avoided or mitigated through careful legal counselling before and during the negotiations between the parties and drafting of the ultimate transactional documents.
A recent decision of the New York Appellate Division, Third Department, is an illustrative case in point: Panessa v Lederfeind, 2024 NY Slip Op 05252 (3rd Dep’t Decided Oct. 24, 2024). In Panessa, the seller (“Seller”) of a business involved in the sale of protein powder and other nutritional supplements and its inventory was stymied in its attempt to collect on a promissory note given by the buyer (“Buyer”) because the Buyer alleged the Seller misrepresented the nature of the protein levels in the inventory. The litigation may have been avoided if the Seller was adequately counselled about making representations that could later come back to haunt it, and/or if the Seller had required the Buyer to disclaim reliance on any extra-contractual, claimed representations.
Panessa Facts
In Panessa, inventory of protein products was part of the sale of the business. In arriving at the agreed upon value of the inventory, Seller provided Buyer with a certificate of analysis that purported to verify certain protein concentration in the products. Buyer then agreed to purchase the inventory and executed a promissory note for the purchase price. After receiving the inventory, Buyer questioned whether the protein levels were as high as Seller had affirmed and retained an independent laboratory to test the products, which reported starkly lower protein levels than the certificate of analysis and product labels. Buyer then attempted (in some manner unspecified by the Court) to rescind the sale, which Seller rejected, and Buyer then just stopped paying the promissory note for the product inventory.
While the Buyer apparently did not make an effective attempt to convince the Seller of its position, the Seller proceeded to sue to enforce the promissory note. The Seller used a short-cut procedural device to go straight to a judgment without any pretrial proceedings or trial, called a motion for summary judgment in lieu of complaint (see CPLR 3213). In such a proceeding, the party seeking to enforce the promissory note simply must present evidence of the existence and execution of the note, and that the promisor failed to pay as required under it. The Seller did that. The legal burden of proof then shifted to the promisor—here the Buyer—to raise issues as to why the note should not be enforced.
The Buyer claimed in opposition to the motion, among other things, that it had been fraudulently induced into executing the promissory note based upon Seller’s misrepresentations related to the protein levels. The Court below nevertheless granted the Seller’s motion for summary judgment. The Buyer then appealed to the Third Department. The Third Department reversed.
Seller’s Alleged Representations Are Sufficient to Raise Issues Precluding Judgment for Buyer
The Third Department considered the evidence submitted by the Buyer as to the Seller’s representations about the level of protein in the products that were sold, and found it sufficient to preclude the Seller from obtaining summary judgment to enforce payment under the promissory note. First, the Third Department observed that fraud is certainly a valid defense, particularly with respect to enforcement of a promissory note:
Fraud in the inducement is a defense to the enforcement of a promissory note (see Creative Culinary Concepts, LLC v Sam Greco Constr., Inc., 134 AD3d 1294, 1295 [3d Dept 2015]), and, as such, defendants were required to “allege that (1) the plaintiff made a representation or a material omission of fact which was false and the plaintiff knew to be false, (2) the misrepresentation was made for the purpose of inducing the defendant to rely upon it, (3) there was justifiable reliance on the misrepresentation or material omission, and (4) injury” (Emigrant Mtge. Co., Inc. v Public Adm’r of Kings County, 207 AD3d 437, 441 [2d Dept 2022] [internal quotation marks and citation omitted]; see Piccirilli v Benjamin, 226 AD3d 1233, 1235-1236 [3d Dept 2024]).
In considering the evidence offered by the Buyer, the Third Department explained:
To support the assertion that they had been fraudulently induced, [Buyer] supplied the laboratory analysis that [Seller] had provided prior to the sale, which purported to demonstrate that the various protein powders had between 23 and 25 grams of protein per 33.5 gram serving. [Buyer] then submitted the results of the independent laboratory analysis indicating that the protein levels in the products were significantly lower than [Seller] had avowed prior to the sale. This analysis indicated that there was between 21 and 26 grams of protein per 100 grams tested, equating to between 7 and 9 grams of protein per 33.5 gram serving. In addition to the foregoing, [Buyer] supplied an affidavit … which detailed the [Buyer’s ] communications with [Seller] after discovery of this disparity, during which [Seller] indicated that the results were normal and instructed [Buyer] on how to modify the labeling of the product in a way that would not alert consumers.
The Third Department then concluded that based upon this evidence, the Buyer had satisfied its burden of raising issues of fact:
Generally, “what constitutes reasonable reliance is always [a] nettlesome” inquiry best left to the trier of fact (DDJ Mgt., LLC v Rhone Group L.L.C., 15 NY3d 147, 155 [2010] [internal quotation marks and citation omitted]; see Offshore Exploration[*3] & Prod., LLC v De Jong Capital, LLC, 225 AD3d 427, 429 [1st Dept 2024]). Furthermore, “[s]ummary judgment is a drastic remedy that should not be granted where there is any doubt as to the existence of triable issues of fact” (Piccirilli v Benjamin, 196 AD3d 895, 896-897 [3d Dept 2021] [internal quotation marks and citations omitted]). As such, we find that Supreme Court erred in granting [Seller]’s motion. Based upon the foregoing proof, [Buyer] satisfied their burden of proof to establish a bona fide defense to liability as there are material questions of fact as to whether [Buyer was ] fraudulently induced to execute the note in question (see Denjonbklyn, Inc. v Rojas, 154 AD3d 734, 735 [2d Dept 2017]; compare Creative Culinary Concepts, LLC v Sam Greco Constr., Inc., 134 AD3d at 1295; Bank of Am., N.A. v Lang Indus., Inc., 127 AD3d 1457, 1458-1459 [3d Dept 2015]).
Commentary
Lessons can be gleaned from the decision in Panessa. First, it did appear that there was evidence of the Seller misrepresenting the quality and nature of the products in question, and later recommending deceptive solutions. Obviously, a seller should refrain from any type of deception in connection with such a transaction, including the true nature of the sale goods. Counsel representing the seller should offer effective guidance to avoid any form of misinformation. Better proactively to address such issues while the transaction is being negotiated than dealing with the consequences later.
Second, to mitigate against subsequent claims from a buyer that representations were in fact made to induce action, it is always prudent for the seller to make sure any and all representations about the subject of the sale are specifically identified in the transactional agreements themselves, while the buyer should also be required to acknowledge that it is not and was not relying upon any other representations of the seller to make the deal. Such no-reliance disclaimers are essential, and limitations of remedies for breach of any explicit contractual representations or warranties should be considered.
On the Buyer’s end of things in Panessa, while the Court’s decision did not specify how the Buyer “attempted to rescind the sale,” whatever the Buyer did was not effective in dissuading the Seller from proceeding to try to enforce the promissory note through the lawsuit. The case law cited by the Third Department (and its resulting decision) would be compelling reasons for the Seller to rethink the lawsuit, or at the least, make a better attempt to resolve the issues.