Sophisticated investors and others involved in complex transactions, including mergers, acquisitions and other purchase agreements often face an uphill battle in later seeking to allege they were defrauded in connection with such transactions, especially where the contracts contain detailed and comprehensive disclaimers and non-reliance provisions. I have chronicled many such recent cases. These claims are not, however, insurmountable, as illustrated by a recent decision in the U.S. District Court for the Southern District of New York: Joseph v. Mobileye, N.V., 2016 WL 7488857 (S.D.N.Y Dec. 13, 2016).
Joseph involves a familiar factual setting: Investors who become minority owners of a business and who are not directly involved in the operations or management are induced to sell out, only later to discover that they were misled about future prospects for the company, thereby losing the opportunity for the significant upside of remaining an owner. (I actually won a $12.7 million judgment after a jury verdict in a case in which I represented the minority owners of a corporation who were duped into selling their stock before a huge sale of the company, which was deceptively hidden from them.)
As revealed below, the key lesson to be learned from Joseph is that the pre-deal information and communications must be controlled and vetted by legal counsel. Oral communications should be limited and meticulously screened for accuracy. And then, specific non-reliance provisions and disclaimers used, which must not be neutralized by oral statements. Everything that could be claimed to have been relied upon must be identified and documented in the contractual agreements and schedules.
Specifically in Joseph, the plaintiffs invested in a Netherland private corporation. Ten years after the investment, the company (called Mobileye) issued a tender offer (“Offer”) for the current owners to sell their shares to another entity. Plaintiffs alleged that to induce them to sell their shares, Mobileye’s CFO represented “that Mobileye was then valued at $1.6 billion, but that in six years it ‘should be valued at $3 billion,’ at which time Mobileye would evaluate another round of financing or an IPO. … [The CFO] ‘made it clear’ that an IPO was not then being considered or contemplated by Mobileye, and that the upside potential for existing shareholders, like [plaintiffs], was extremely limited for the next six years or more.”
Plaintiffs further alleged that because they did not want to wait six years, and their current return was satisfactory, they sold at that time. Shortly after the sale, there were news reports that Mobileye was preparing for an IPO. Ten months after the sale by plaintiffs, Mobileye indeed went public. The IPO valued Mobileye at $5.31 billion at the beginning of the first day of trading and at $7.97 billion at the close of the first day of trading. A few months later, Mobileye closed a secondary offering of 19,696,050 ordinary shares at a price of $41.75 per share. The secondary offering was by shareholders who had acquired their shares prior to Mobileye’s IPO. Obviously, plaintiffs took a big hit by selling out earlier, based upon what they alleged, was false information about the company’s plans for the future.
The plaintiffs then brought claims (in New York state court subsequently removed to the USDC, SDNY), alleging fraud, negligent misrepresentation, and unjust enrichment, based on the company’s alleged misstatements about its value and plans for an IPO, which induced plaintiffs to sell their shares prior to the IPO for a fraction of their value. Defendants then moved to dismiss the amended complaint.
The Court observed the procedural context of the motion under FRCP 12(b)(6), applying the standards in Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) and Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007). The Court also acknowledged that FRCP 9(b) applied, requiring the allegations of fraud to be alleged with particularity. The Court gave a useful summary of the standards under FRCP 9(b):
Rule 9 (b) of the Federal Rules of Civil Procedure (“Rule 9(b)”) requires that a party “alleging fraud or mistake … must state with particularity the circumstances constituting fraud or mistake.” Fed. R. Civ. P. 9(b). “To satisfy this Rule, a complaint alleging fraud must (1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent.” United States ex rel. Ladas v. Exelis, Inc., 824 F.3d 16, 25 (2d Cir. 2016) (internal quotation marks omitted).
“Despite the generally rigid requirement that fraud be pleaded with particularity, allegations may be based on information and belief when facts are peculiarly within the opposing party’s knowledge.” Wexner v. First Manhattan Co., 902 F.2d 169, 172 (2d Cir. 1990). “Where pleading is permitted on information and belief, a complaint must adduce specific facts supporting a strong inference of fraud or it will not satisfy even a relaxed pleading standard.” Id.
Rule 9(b) states that “[m]alice, intent, knowledge, and other conditions of a person’s mind may be alleged generally.” Fed. R. Civ. P. 9(b). This “relaxation of Rule 9(b)’s specificity requirement for scienter ‘must not be mistaken for license to base claims of fraud on speculation and conclusory allegations.’ ” Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir. 1994) (quoting O’Brien v. Nat’l Prop. Analysts Partners, 936 F.2d 674, 676 (2d Cir. 1991)). Thus, although Rule 9(b) permits that intent be alleged generally, “plaintiffs must assert facts that plausibly support the inference of fraud.” Loreley Financing (Jersey) No. 3 Ltd. v. Wells Fargo Securities, LLC, 797 F.3d 160, 170 (2d Cir. 2015) (quoting Cohen v. S.A.C. Trading Corp., 711 F.3d 353, 360 (2d Cir. 2013)) (internal quotations omitted). “The requisite ‘strong inference’ of fraud may be established either (a) by alleging facts to show that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness.” Shields v. Citytrust Bancorp., Inc., 25 F.3d at 1128.
“Whether a given intent existed is generally a question of fact, appropriate for resolution by the trier of fact.” Press v. Chem. Inv. Servs. Corp., 166 F.3d 529, 538 (2d Cir. 1999) (internal citation omitted). Similarly, the inquiry into the reasonableness of reliance “is ‘always nettlesome because it is so fact-intensive’ and ‘ordinarily a question of fact to be determined at trial.’ ” In re Eugenia VI Venture Holdings, Ltd. Litig., 649 F.Supp.2d 105, 119 (S.D.N.Y. 2008), aff’d sub nom. Eugenia VI Venture Holdings, Ltd. v. Glaser, 370 Fed.Appx. 197 (2d Cir. 2010) (quoting Schlaifer Nance & Co. v. Estate of Warhol, 119 F.3d 91, 98 (2d Cir. 1997) and Computech Int’l, Inc. v. Compaq Computer Corp., No. 02 CIV 2628, 2004 WL 1126320, at *9 (S.D.N.Y. May 21, 2004)).
The Court then reviewed the various elements of claims for fraud and negligent misrepresentation and proceeded to address each of the arguments made by defendants seriatim:
- Misrepresentation of fact. Defendants first argued that plaintiffs did not allege any specific misrepresentations of fact, only future intentions. The Court rejected this argument, noting that the plaintiffs did allege that Mobileye’s CFO represented that the company was not planning an IPO when in fact it allegedly was. This was the key mistake made by the company during the pre-deal period leading up to the transaction. Obviously, more attention should have been given to what was said, how it was communicated, and documented, so as to avoid a later claim of reliance on false statements.
- Inference of fraud. Mobileye next argued that plaintiffs failed “to allege facts that support an inference of fraud because it would have made no sense for Mobileye or its executives to sell their shares for a price that they knew undervalued the company when there was no minimum number of shares required to be sold in the Offer.” The Court rejected this argument, observing: “There is no dispute that the IPO was an important step in Mobileye’s development that raised substantial amounts of money for Mobileye and enriched its existing shareholders. The Amended Complaint alleges that Mobileye sought, through the Offer, to acquire up to 24 percent of the outstanding shares and sell those shares to institutional investors in order to facilitate the IPO.”
- Disclaimers and non-reliance. Next, Mobileye argued “that a plaintiff ‘cannot rely on misleading oral statements … when the offering materials contradict the oral assertions.’” In fact, the offering materials and transactional documents did contain typical disclaimers: “The Offer documents required shareholders selling their shares to acknowledge that they were giving up any future appreciation in the value of their shares. In agreeing to tender [their] shares pursuant to the Offer, [plaintiffs also] agreed that [they] understood that [they] would ‘forgo any future appreciation … in the value of the shares tendered, including if the Company were to complete an [IPO]’ and that [they were] ‘not relying on any representations about the future business or financial projections of the Company in making [their] decision to sell.’” The Court rejected this argument as well, finding that it was in fact reasonable for plaintiffs to rely on the CFO’s statements about the company’s intentions, as he was specifically identified in the offering as the person to which inquiries should be directly. Also, the Court ruled that it could not resolve these issues in favor of defendants on a motion to dismiss, citing plaintiffs’ position that the alleged misrepresentations of the CFO were actually “consistent with the Offer documentation—they both stated that there was no then—existing plans for an IPO—but misrepresented the actual facts, which were that Mobileye and its executives had already decided to take Mobileye public in the near future and proceeded with the Offer as “part of Mobileye’s run-up to an already expected IPO.”
- Damage causation. In response to defendants’ argument that there was no causation, the Court disagreed, finding it sufficient that plaintiffs alleged that they (1) wanted to retain their shares if Mobileye was close to an IPO; (2) would not have sold their shares pursuant to the Offer but for the CFO’s misrepresentations; and (3) because they sold their shares pursuant to the Offer, they did not receive a fair price for them, which would have incorporated the potential upside of an impending IPO.
- Negligent misrepresentation. The Court also sustained the negligent misrepresentation claim by finding that Mobileye and its CFO had particular knowledge to which plaintiffs did not have access, thereby creating the special relationship necessary on a negligent misrepresentation claim.
While Courts often dispose of fraud claims at the pleadings stage, this case shows that even with sophisticated parties, sufficient earmarks and indicia of fraud will serve to survive (and avoid) early dismissal. To avoid such claims, parties to such transactions must meticulously vet and control pre-deal communications.