Transactions involving the sale of assets, stock, businesses and the like are a fertile ground of potential fraud claims. A typical scenario involves the purchaser being disappointed in the subject of the purchase after the deal and wanting to rescind the sale, or more often, collect monetary damages to compensate for what was allegedly misrepresented by the seller.
In a bit of a twist, one of the most litigated aspects of such fraud claims centers on the actions of the party claiming fraud, rather than the party accused of the fraud. That is, whether the purchaser did enough to protect itself from any alleged misinformation concerning the deal, or whether it acted reasonably in relying upon information provided by the seller or whether such reliance really caused the purchaser to enter the transaction. Closely related to this focus is precisely what the contractual agreement and transactional documents provide about the assets or subject being sold, and the disclaimers of any reliance. Topics in this Blog, such as Justifiable/Reasonable Reliance and Disclaimers collect the many cases and my commentary on this subject.
A recent decision of the Appellate Division, Third Department, does a very nice job of laying out the law and analyzing the issues in this common scenario — Ironwoods Troy, LLC v Optigolf Troy, LLC, 2022 NY Slip Op 02323 (3d Dep’t Decided April 7, 2022).
In Ironwoods, the transaction at issue was an asset purchase agreement (“APA”) for the sale of golf simulator equipment and the related business assets. The buyer agreed to pay for the assets with a down payment, followed by installment payments, the remaining balance on a closing date and backed by personal guarantees. After paying the down payment, the buyers claimed that the owner of the selling LLC misrepresented information to induce them to purchase the assets. The buyers sued and sought rescission of the sale as well as the personal guarantees, alleging fraud, breach of contract and unjust enrichment. The sellers counterclaimed to enforce the sale contract and the personal guarantees.
The lower court granted the defendants summary judgment, dismissed the complaint and ruled that defendants could enforce the contracts. The Third Department affirmed.
On the fraud claim, plaintiffs claimed the owner of the selling LLC made several misrepresentations regarding, among other things, the business’s value and potential earnings as an indoor golf simulator business and the condition of the golf simulator equipment. Plaintiffs also claimed that defendant misrepresented that the buyers could use the sellers’ liquor license.
In affirming summary judgment for the sellers, the Third Department summarized the law on the fraud claim as follows:
“In an action to recover damages for fraud, the plaintiff must prove a misrepresentation or a material omission of fact which was false and known to be false by [the] defendant, made for the purpose of inducing [the plaintiff] to rely upon it, justifiable reliance of [the plaintiff] on the misrepresentation or material omission, and injury” (Lama Holding Co. v Smith Barney, 88 NY2d 413, 421 [1996] [citations omitted]; accord Piller v Princeton Realty Assoc. LLC, 173 AD3d 1298, 1302 [2019]; see Gruber v Donaldsons, Inc., 201 AD3d 887, 888 [2022]). However, “[a] party cannot claim reliance on a misrepresentation when he or she could have discovered the truth with due diligence” (Avery v WJM Dev. Corp., 197 AD3d 1141, 1144 [2021] [internal quotation marks and citation omitted]). Moreover, alleged misrepresentations are not actionable as fraud when they consist of “mere puffery, opinions of value or future expectations, rather than false statements of value” Northern Group Inc. v Merrill Lynch, Piece, Fenner & Smith Inc., 135 AD3d 414, 414 [2016] [internal citations omitted]).
The Third Department then applied the law to the evidence, concluding that plaintiffs’ claimed reliance on misrepresentations as to the equipment’s condition was belied by plaintiffs’ admissions at deposition that they inspected the equipment prior to the sale and found it to be in working order. The court also rejected plaintiffs’ attempt to offer contrary hearsay evidence on the issue, as the context was a motion for summary judgment, in which admissible evidence is required. As to the alleged misrepresentation of value of the business, the court found the “alleged statement that the business had ‘the potential to make [$]450,000 +++’ to be mere puffery rather than a false statement of value (see Northern Group Inc. v Merrill Lynch, Piece, Fenner & Smith Inc., 135 AD3d at 414).” As to the use of the liquor license, the court noted that one of the plaintiffs admitted that he knew they had to use their own liquor license.
As to other claimed misrepresentations, the court focused on plaintiffs’ failure to protect themselves, observing as follows:
Finally, [plaintiff] explained that, as part of the APA, OptiGolf’s stock of liquor was sold to Ironwoods and it was determined that much of this stock was expired and unsaleable. Yet, an email supplied by [defendant] makes clear that plaintiffs were aware, prior to entry of the APA, that certain alcohol had expired and nevertheless proceeded with the purchase. … Fatal to plaintiffs’ fraud claim was their failure to establish that [defendant] made misrepresentations that were false or known to be false or that plaintiffs exercised any due diligence. [Defendant] represented only that he was the developer of the simulators and that they were “proprietary.” Although [defendant] initially assigned a value of $45,000 per unit, [plaintiff] discounted each unit based upon his opinion that the simulators, once purchased, would lose value immediately and performed his own calculations as to what he believed the simulators were worth. [Plaintiff] admitted that, prior to purchasing the assets, he did not perform any due diligence to investigate the indoor golf industry or obtain an independent appraisal of OptiGolf Troy’s assets. Generally, the [plaintiff] did not conduct any in-depth market research with respect to the indoor golf business.
Commentary
In the context of APAs, business sales and the like, buyers truly have an obligation to protect themselves, perform adequate due diligence, independently investigate and verify any statements by the seller, and get any representations in writing. Fraud claims are not likely to survive where the buyer itself has not used whatever means are available to vet the transaction.