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Breach of Contract and Broken Cookies with Fraud and Fiduciary Duty Sprinkles

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  • Posted on: Aug 5 2019

There is almost nothing more frustrating, or potentially costlier, to a business than a dispute over the meaning of a contract. Such disputes can take many forms. It may be that the language used is ambiguous; or the language is reasonably clear but is susceptible to different meanings; or although the language is clear, taken literally, it might not reflect the parties’ intent; or, as is often the case, an event has occurred that was not contemplated by the parties at the time of drafting, so the contract does not specifically provide for it.

When parties enter into a contract, each assumes that the language in their agreement accurately memorializes their understandings and intentions. For this reason, when a dispute arises, the courts in New York look to the intent of the parties as expressed by the language they chose to put into their writing. Ashwood Capital, Inc. v. OTG Mgt., Inc., 99 A.D.3d 1 (1st Dept. 2012). A clear, complete document will be enforced according to its terms. Id. at 7.

When the parties have a dispute over the meaning of their contract, the court first asks if the contract contains any ambiguity. Id.  Since New York is a textual jurisdiction (where the courts look to the agreement itself to determine the meaning of the agreement), whether there is ambiguity “is determined by looking within the four corners of the document, not to outside sources.” Kass v. Kass, 91 N.Y.2d 554, 566 (1998). Thus, courts will examine the parties’ intentions as set forth in the agreement and give the language an interpretation that is sensible, practical, fair, and reasonable. Riverside S. Planning Corp. v. CRP/Extell Riverside, L.P., 13 N.Y.3d 398, 404 (2009); Abiele Contr. v. New York City School Constr. Auth., 91 N.Y.2d 1, 9-10 (1997); Brown Bros. Elec. Contr. v. Beam Constr. Corp., 41 N.Y.2d 397, 400 (1977).

A contract is not ambiguous if, on its face, it is definite and precise and reasonably susceptible to only one meaning. White v. Continental Cas. Co., 9 N.Y.3d 264, 267 (2007). The “parties cannot create ambiguity from whole cloth where none exists, because provisions are not ambiguous merely because the parties interpret them differently.” Universal Am. Corp. v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 25 N.Y.3d 675, 680 (2015) (citation and internal quotation marks omitted).

“Whether or not a writing is ambiguous is a question of law to be resolved by the courts.” WWW Assocs., Inc. v Giancontieri, 77 N.Y.2d 157, 162 (1990). “[E]xtrinsic and parol evidence is not admissible to create an ambiguity in a written agreement which is complete and clear and unambiguous upon its face.” Id. at 163. This rule is especially applicable where the parties are commercially sophisticated, and their contract contains a merger clause. Schron v. Troutman Sanders LLP, 20 N.Y.3d 430, 436 (2013) (“where a contract contains a merger clause, a court is obliged to require full application of the parol evidence rule in order to bar the introduction of extrinsic evidence to vary or contradict the terms of the writing.”) (citation and quotation marks omitted).

Finally, since a “contractual provision that is clear on its face must be enforced according to the plain meaning of its terms,” Bank of N.Y. Mellon v. WMC Mortg., LLC, 136 A.D.3d 1, 6 (1st Dept. 2015) (citation omitted), courts may not “add or excise terms, nor distort the meaning of those used and thereby make a new contract for the parties under the guise of interpreting the writing.” Id. (citations omitted). This is especially so “in commercial contracts negotiated at arm’s length by sophisticated, counseled business people.” Id.

Sometimes, a contract dispute gives rise to other claims, such as fraud and breach of fiduciary duty. In each instance, the plaintiff must allege “a legal duty independent of the contract” or a misrepresentation or breach that is “collateral or extraneous to the terms of the parties’ agreement” to withstand a dismissal motion for being duplicative of the contract claim. Dormitory Auth. v. Samson Constr. Co., 30 N.Y.3d 704 (2018) (citation omitted).

Recently, Justice Saliann Scarpulla of the Supreme Court, New York County, Commercial Division, addressed the foregoing issues in Barnett v. Seth Berkowitz Serve U Brands Inc., 2019 N.Y. Slip Op. 32257(U) (Sup. Ct., N.Y. County July 29, 2019) (here).

Barnett v. Seth Berkowitz Serve U Brands Inc.

Background

Barnett arose from the sale of an equity interest in a cookie business that would soon become a successful enterprise and the subject of an acquisition by Krispy Kreme.

In 2003, Plaintiff, Jared Barnett (“Barnett”), and Defendant, Seth Berkowitz (“Berkowitz”), co-founded Insomnia Cookies, LLC (“Insomnia”), a company engaged in the business of baking and delivering cookies, especially late at night. By March 2006, Barnett and Berkowitz owned 29.332% and 44.000%, respectively, in the company.

In 2006, Barnett and Berkowitz agreed that Barnett would sell his equity interest in Insomnia to Berkowitz. Barnett alleged that Berkowitz confirmed the terms of the sale in an attachment to a May 4, 2006 email (the “May 2006 Email”). Among other things, the email provided that Barnett would receive “all economic benefits of a 5% member in Insomnia Cookies, LLC.”

About one month later, on June 8, 2006, Barnett and Berkowitz signed a buy-out agreement (the “Buy-Out Agreement”), pursuant to which: (a) Barnett resigned as Insomnia’s manager; and (b) Berkowitz acquired Barnett’s equity interest in Insomnia in exchange for (1) payments to Barnett aggregating $90,000, and (2) Barnett retaining a seller benefit (the “Retained Seller Benefit”) of 6.8% non-voting interest in the proceeds received by Berkowitz as a result of any Insomnia “Liquidation Event.” The Buy-Out Agreement defined a Liquidation Event to mean, inter alia, any transaction that resulted in the transfer of Berkowitz’s equity interests in Insomnia to a third-party, and a restructuring, financing, recapitalization or other structuring transaction that diluted Berkowitz’s interest in Insomnia.

On September 17, 2018, Krispy Kreme acquired Insomnia (the “Krispy Kreme Transaction”). According to Barnett, Berkowitz received more than $29 million in connection with the Krispy Kreme Transaction. Barnett alleged that the transaction constituted a Liquidation Event under the Buy-Out Agreement pursuant to which he was entitled to receive money. Barnett claimed that he did not receive any money from the transaction.

In his Amended Complaint, Barnett pleaded nine causes of action for: (i) breach of contract; (ii) breach of the implied covenant of good faith and fair dealing; (iii) interference with contractual relations; (iv) contractual indemnification; (v) declaratory judgment; (vi) injunctive relief; (vii) breach of fiduciary duty; (viii) fraud and misrepresentation; and (ix) accounting.

Defendants moved to dismiss the Amended Complaint, arguing that Barnett failed to state a claim and that documentary evidence disproved his claims as a matter of law.

The Court granted in part and denied in part the motion.

The Court’s Decision

Breach of Contract Causes of Action

Defendants argued that Barnett’s breach of contract claims, which were based on Berkowitz’s alleged failure to give Barnett a 5% economic benefit in the Krispy Kreme Transaction, must be dismissed because the language in the Buy-Out Agreement explicitly contradicted Barnett’s allegations.

In response, Barnett maintained that the operative and enforceable agreement between the parties included both the Buy-Out Agreement and the May 2006 Email and that only by reference to the May 2006 Email could the full agreement of the parties and their intentions be determined. Barnett further maintained that both documents were part of an integrated transaction and should therefore be interpreted together.

Justice Scarpulla found that “the Buy-Out Agreement [was] a complete, unambiguous agreement, … which clearly set[] out the terms agreed upon by both Barnett and Berkowitz.” Slip Op. at *4. Having determined the foregoing, the Court held that, at the pre-answer stage of the proceeding, Barnett stated a claim for breach of contract. The Court explained:

Barnett alleges that, after execution of the Buy-Out Agreement, Berkowitz owned 73.332% of the equity interest in Insomnia, and Barnett owned a 6.8% non-voting interest in the proceeds received by Berkowitz as a result of any Insomnia “Liquidation Event.” Barnett further alleges that a Liquidation Event occurred when Holdings acquired Insomnia, and Berkowitz has failed to pay Barnett for his interest in the proceeds of that Liquidation Event. At this pre-answer motion to dismiss stage, Barnett has sufficiently pled that there is an underlying contract (the Buy-Out Agreement), which entitles Barnett to 6.8% interest in Berkowitz’s equity interest and that Barnett was not paid any such benefit after a Liquidation Event (including the Krispy Kreme Transaction).

Id. at **4-5 (footnote omitted).

Breach of Fiduciary Duty Causes of Action

To plead a breach of fiduciary duty, a plaintiff must plead “the existence of a fiduciary relationship, misconduct by the other party, and damages directly caused by that party’s misconduct.” Pokoik v. Pokoik, 115 A.D.3d 428, 429 (1st Dept. 2014) (citation omitted). “A fiduciary relationship exists between two persons when one of them is under a duty to act for or to give advice for the benefit of another upon matters within the scope of the relation” but generally does not arise “between those involved in arm’s length business transactions.” EBC I, Inc. v. Goldman, Sachs & Co., 5 N.Y.3d 11, 19 (2005) (citations and quotation marks omitted). “If the parties … do not create their own relationship of higher trust, courts should not ordinarily transport them to the higher realm of relationship and fashion the stricter duty for them.” Id. at 20.

Defendants argued that the Buy-Out Agreement was an arm’s-length business transaction in which no fiduciary duty attached. Defendants maintained that Barnett held no interest in Insomnia after the Buy-Out Agreement and any dilution of Berkowitz’s equity interest, even if undertaken by Berkowitz directly, would not have constituted a breach of fiduciary duty.

In response, Barnett argued that the Buy-Out Agreement made it clear that a relationship of trust was created thereunder. According to Barnett, he was the beneficiary of the But-Out Agreement; Berkowitz was the trustee; and the 6.8% of Berkowitz’s interest in Insomnia along with distributions or interests that Barnett would thereafter acquire on account of his equity interest in Insomnia was trust property and upon closing of the transaction under the Buy-Out Agreement, there was actual delivery or legal assignment of trust property to Berkowitz.

The Court agreed with Defendants, holding that Barnett failed to plead the existence of a fiduciary relationship. The Court explained that “[a]part from Berkowitz’s contractual obligation to pay Barnett in the event of a Liquidation Event, Barnett did not retain any other right or benefit under the Buy-Out Agreement and the Buy-Out Agreement did not put Berkowitz under a duty to act for the benefit of Barnett.” Slip Op. at *11. “Because the essential element of a breach of fiduciary duty cause of action – the existence of a fiduciary duty – has not been adequately pled,” the Court dismissed “this cause of action.” Id.

Fraud Cause of Action

To plead a cause of action for fraud, the plaintiff must allege “a misrepresentation or a material omission of fact which was false and known to be false by defendant, made for the purpose of inducing the other party to rely upon it, justifiable reliance of the other party on the misrepresentation or material omission, and injury.” Genger v. Genger, 152 A.D.3d 444, 445 (1st Dept. 2017) (citation and quotation marks omitted). The allegations must be stated with particularity to satisfy CPLR 3016(b). Id. Thus, the plaintiff must provide sufficient facts to support a “reasonable inference” that the allegations of fraud are true. Id. at 559-60. Conclusory allegations will not suffice. Id. Neither will allegations based on information and belief. See Facebook, Inc. v. DLA Piper LLP (US), 134 A.D.3d 610, 615 (1st Dept. 2015) (“Statements made in pleadings upon information and belief are not sufficient to establish the necessary quantum of proof to sustain allegations of fraud.”).

Although, CPLR 3016 (b) provides that “the circumstances constituting the [fraud] shall be stated in detail,” the New York Court of Appeals has “cautioned that section 3016 (b) should not be so strictly interpreted as to prevent an otherwise valid cause of action in situations where it may be impossible to state in detail the circumstances constituting a fraud.” Pludeman v. Northern Leasing, Sys., Inc., 10 N.Y.3d 486, 491 (2008) (internal quotation marks and citations omitted). Thus, where the facts “are peculiarly within the knowledge of the party charged with the fraud,” and “it would work a potentially unnecessary injustice to dismiss a case at an early stage where any pleading deficiency might be cured later in the proceedings,” dismissal should be denied. Id. at 491-92 (internal quotation marks and citations omitted). See also CPC Intl. v. McKesson Corp., 70 N.Y.2d 268, 285-286 (1987).

Defendants argued that Barnett’s fraud claim should be dismissed because it was time barred due to the fact that all alleged misrepresentations occurred in 2006 and otherwise insufficiently particular to withstand a motion under CPLR § 3016(b).

“[A] fraud-based action must be commenced within six years of the fraud or within two years from the time the plaintiff discovered the fraud or could with reasonable diligence have discovered it.” Sargiss v. Magarelli, 12 N.Y.3d 527, 532 (2009) (citations and quotation marks omitted). “Where a plaintiff relies upon the two-year discovery exception to the six-year limitations period, the burden of establishing that the fraud could not have been discovered prior to the two-year period before the commencement of the action rests on the plaintiff who seeks the benefit of the exception.” Cannariato v. Cannariato, 136 A.D.3d 627, 627 (2d Dept. 2016) (citations and quotation marks omitted); accord Endervelt v. Slade, 214 A.D.2d 456, 457 (1st Dept. 1995).

The cause of action accrues when “every element of the claim, including injury, can truthfully be alleged” (Carbon Capital Mgmt., LLC v. Am. Express Co., 88 A.D.3d 933, 939 (2d Dept. 2011)  (citation and alterations omitted)), “even though the injured party may be ignorant of the existence of the wrong or injury.” Schmidt v. Merchants Despatch Transp. Co., 270 N.Y. 287, 300 (1936).

In response, Barnett argued that Berkowitz’s fraudulent conduct first came to his attention in August 2018, when the Court ordered Berkowitz to provide information about Berkowitz’s equity interest, and information respecting Insomnia and its business. Therefore, contended Barnett, the statute of limitations on his fraud cause of action began to run after August 2018.

The Court rejected Barnett’s argument, holding that the fraud claim was time-barred:

Under the plain terms of the Buy-Out Agreement, Berkowitz was under no obligation to disclose to Barnett any information regarding the sale of Berkowitz’s equity interests in Insomnia. And Barnett made no effort to get any information about his Retained Seller Benefit from Berkowitz between execution of the Buyout Agreement in 2006 and the commencement of this action in 2018. As Barnett has not alleged facts to show that he sought to obtain information about his Retained Seller Benefit for more than ten years before commencing this action, Barnett has not met his burden of showing that Berkowitz’s alleged fraud could not have been discovered, even with the benefit of the discovery rule, prior to expiration of the statute of limitations

Slip Op. at *13 (citation omitted).

Takeaway

Contracts are often at the heart of business and commercial disputes. Not all contract disputes result in litigation. A well-drafted contract can often prevent or resolve a dispute before the parties run to court. But, as Barnett shows, when the parties cannot resolve their differences, and resort to litigation, it is important to understand the rules governing the breach of contract claim.

Barnett also shows the importance of demonstrating the existence of a duty separate from the contractual one. Conduct amounting to breach of a contractual obligation may also constitute the breach of a duty arising out of the relationship created by contract which is independent of that contract. In Barnett, Justice Scarpulla found that there was no relationship independent of the contractual one.

Finally, Barnett reminds litigants to pursue the prosecution of their claims as soon as they are known. Although determining when accrual occurs, and when the claim should have been discovered, is not easy and often contested, New York law is clear that “where the circumstances are such as to suggest to a person of ordinary intelligence the probability that he has been defrauded, a duty of inquiry arises, and if he omits that inquiry when it would have developed the truth, and shuts his eyes to the facts which call for investigation, knowledge of the fraud will be imputed to him.” Gutkin v. Siegal, 85 A.D.3d 687, 688 (1st Dept. 2011) (citation and internal quotation marks omitted). In Barnett, as noted, the Court found that Plaintiff did not undertake such an inquiry.

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