Nearly twenty years ago, the Appellate Division, First Department rocked the transactional world by throwing out a release and undoing a sale transaction between owners of a limited liability company based upon the unbending fiduciary duties the managing member of the LLC owed to the other (50%) member, in the decision in Blue Chip Emerald LLC v. Allied Partners Inc., 299 A.D.2d 278 (1st Dept. 2002). The decisional law has evolved quite a bit since that time, making it much more difficult to bring or establish such a claim, including for fraudulent inducement. A new decision of the First Department (Silver Point Capital Fund, L.P. v Riviera Resources, Inc., 2021 NY Slip Op 05312 (1st Dep’t Decided Oct, 5, 2021)) underscores the sea change.
Evolving Law of Fiduciary Releases
I summarized the turnaround in the law in my October 27, 2011 article in the New York Law Journal “Grappling With Fiduciary Duties in Enforcing Contracts.” The factual context is the sale of an owner’s interest in any type of business entity to the other owner(s). The law recognizes fiduciary duties that are owed by one owner (including managing members, corporate officers, partners) to the other owners. In a sale transaction between these parties, the fiduciary duties would apply, requiring affirmative obligations to disclose relevant information to the other owner, whether requested or not. As the law has evolved, however, circumstances can dispense with the ordinary fiduciary duties, such as where the owners are at odds with each other and their relationship “is no longer one of unquestioning trust,” or where their contract specifically disclaims any such duties. See Centro Empresarial Cempresa S.A. v América Móvil, S.A.B. de C.V., 17 NY3d 269, 277 (2011).
These principles affect claims of fraud and fraudulent inducement in various ways, including where an owner who is selling its interest to the other owner seeks to avoid a release given to or sale transaction with the other owner. The leading Court of Appeals decision in Centro is instructive. In Centro, plaintiffs alleged that they were induced to sell their minority interest in a foreign mobile telephone company by misrepresentations made to them by the majority owner concerning the value of the underlying enterprise. In the purchase agreement, the parties executed and exchanged a broadly worded mutual release, including of any interest in the underlying enterprise. Plaintiffs claimed they were fraudulently induced to sell their interest for less than $130 million, while information they later discovered indicated that their interest allegedly would have been worth more than $1 billion several years later.
The trial court denied defendants’ motion to dismiss, but the First Department reversed. The Court of Appeals affirmed the First Department’s dismissal of the complaint. The Court acknowledged that a release may be invalidated based on the same grounds any agreement can be set aside, such as duress, illegality, fraud or mutual mistake. The Court, however, rejected plaintiffs’ claim of fraud in an attempt to invalidate the release, because the alleged fraud involved the very subject that the release was intended to cover—the value of the membership interest.
Focusing on the impact of defendant’s fiduciary duty to plaintiffs, the Court did acknowledge that ‘as a majority shareholder in a closely held corporation, [it] owed a fiduciary duty to plaintiffs, minority shareholders [and] was therefore required to ‘disclose any information that could reasonably bear on plaintiffs’ consideration of [its purchase] offer’.’ The Court announced, however, that a “sophisticated principal is able to release its fiduciary from claims—at least where, as here, the fiduciary relationship is no longer one of unquestioning trust—so long as the principal understands that the fiduciary is acting in its own interest and the release is knowingly entered into.” The Court then cautioned that “[t]o the extent that Blue Chip and similar decisions suggest otherwise, they misapprehend our case law.” The Court emphasized that the complaint itself alleged that “plaintiffs knew that defendants had not supplied them with the financial information necessary to properly value their interests, yet chose to cash out their interests and release defendants from fraud claims without demanding either access to the information or assurances as to its accuracy in the form of representations and warranties.” The Court concluded that “plaintiffs have been so lax in protecting themselves that they cannot fairly ask for the law’s protection.”
This case law served as the foundation for the First Department’s recent decision in Silver Point.
Silver Point
In Silver Point, plaintiffs, former minority shareholders of defendant corporation, claimed that the defendant fraudulently induced them to sell to defendant all of their shares in the corporation, just three weeks before defendant announced an asset sale of its most valuable properties, after which share prices soared and defendant made a substantial distribution to the remaining shareholders.
The lower court dismissed these claims and the First Department affirmed.
The First Department started with the parties’ agreement, which contained a broad release of the defendant. The Court held: “Plaintiffs’ fraud-based claims are barred by the release in the letter agreement dated August 6, 2019 (Letter Agreement) executed by the parties. Information regarding a planned asset sale and distribution, clearly and unambiguously falls within the scope of this release.” (Footnote omitted.)
The Court rejected several different arguments that plaintiffs made in an attempt to impose a duty on the defendant to disclose the impending asset sale, under the “peculiar knowledge” doctrine, special facts doctrine and other theories:
The Letter Agreement sets forth the types of information that were potentially not being disclosed in sufficient detail to enable plaintiffs to make an informed decision as to whether or not to execute the release (see OppenheimerFunds, Inc. v TD Bank, N.A., 2014 NY Slip Op 30379[U], *27-28 [Sup Ct, NY County 2014]; Harborview Master Fund, LP v LightPath Tech., Inc., 601 F Supp 2d 537, 546 [SD NY 2009]). Further, defendant did not make any misleading partial disclosures (see generally Basis Yield Alpha Fund [Master] v Goldman Sachs Group, Inc., 115 AD3d 128, 135 [1st Dept 2014]).
The “peculiar knowledge” doctrine does not apply; plaintiffs are sophisticated parties that were aware that they were not provided with full information but nonetheless agreed to go forward with a transaction without either demanding access to the omitted information or assurances in the form of representations and warranties (see Centro Empresarial Cempresa S.A. v AmÉrica MÓvil, S.A.B. de C.V., 17 NY3d 269, 278-279 [2011]; Rodas v Manitaras, 159 AD2d 341, 343 [1st Dept 1990]; Blink v Johnson, 2015 NY Slip Op 32975[U], *23-24 [Sup Ct, Westchester County 2015]; O.F.I. Imports Inc. v General Elec. Capital Corp., 2016 WL 5376208, *6, 2016 US Dist LEXIS 131565, *19-20 [SD NY Sept. 26, 2016]. For the same reason, the special facts doctrine also does not apply (see Greenman-Pedersen, Inc. v Berryman & Henigar, Inc., 130 AD3d 514, 516 [1st Dept 2015], lv denied 29 NY3d 913 [2017]).
Even if the parties are in a fiduciary relationship, this does not invalidate the release, which was negotiated in the context of an arm’s-length business transaction (see Centro, 17 NY3d at 278; Kafa Invs., LLC v 2170-2178 Broadway LLC, 114 AD3d 433 [1st Dept 2014], lv denied 24 NY3d 902 [2014]).
The Court also flatly rejected the fraudulent inducement claim:
Plaintiffs’ fraudulent inducement claim fails because plaintiffs did not allege a “separate fraud from the subject of the release” and because they could not have justifiably relied on the alleged oral misrepresentation in view of the express no-additional-representations clause in the Letter Agreement (see Avnet, Inc. v Deloitte Consulting LLP, 187 AD3d 430, 431-432 [1st Dept 2020]).
Commentary
Like many decisions, the Silver Point decision shows that parties to a substantial transaction need to be mindful of the important ways to protect themselves. For fiduciaries who do not wish to be bound by ordinary duties of disclosure, contractual language and disclaimers such as those used in Centro and Silver Point are effective. For the party who is selling its interest, care should be taken to protect against non-disclosure, including asking for full information, performing adequate due diligence and avoiding or limiting contractual disclaimers.